The Fed’s Quandary: Speculative Fervor Around Inflation Expectations

Published on
January 21st, 2021
Duration
33 minutes


The Fed’s Quandary: Speculative Fervor Around Inflation Expectations

Daily Briefing ·
Featuring Haley Draznin, Ed Harrison, and Michael Lebowitz

Published on: January 21st, 2021 • Duration: 33 minutes

Michael Lebowitz, partner at Real Investment Advice, joins Real Vision managing editor Ed Harrison to discuss where inflation is headed and whether the market’s bet on the Fed getting it right this time has merit. Lebowitz discusses the nature of market price action for the past several months as risk assets have caught on fire and sector rotation has been occurring with incredible speed. With the growth of M1 and the velocity of money moving in opposite directions, Harrison and Lebowitz explore how the Fed might have to rethink their quantitative easing (QE) operations in order to achieve their goals of generating inflation. In light of this context, Lebowitz discusses his investment approach in this market environment. In the intro, Real Vision’s Haley Draznin checks out the markets on the first full day of President Biden’s holding office.

Comments

Transcript

  • DA
    David A.
    23 January 2021 @ 00:36
    I read Michael’s stuff all the time. Encourage others to go to the RIA website to read his strong articles.
  • DM
    Don M.
    22 January 2021 @ 19:44
    The most important part of what was said, for investors, is that the macro picture means so much less in a market dominated by trillions of new dollars being thrown at the market. You need a process to follow what's working, regardless of how dumb it is.
  • SM
    Sam M.
    22 January 2021 @ 08:41
    This guy is so confused but explained the solution to his own problem and he doesn't even realise it. He talks about QE creating reserves (true); and that the reserves can't get into the economy (true enough) but then he talks about monetary aggregates and velocity ... seriuosly? Of course supply and velocity are opposites if what he said is true ... if money supply includes reserves and reserves can't be spent (and assume output ie PxQ is constant) of course they are offsetting. I will just bang my head on my desk ... or stop watching.
    • JL
      J L.
      22 January 2021 @ 09:07
      The thing about "reserves can't be spent" is also bogus. Reserves are nothing more than restricted cash, and the Fed took all the restrictions off. They come into play when the banks get motivated again, which reasonably happens post-vaccine. "As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions." https://www.federalreserve.gov/monetarypolicy/reservereq.htm
    • mf
      massimo f.
      22 January 2021 @ 17:16
      Reserves can be spent (loaned), that is their purpose. The problem is, they aren't. If you look at the excess reserves data on Fred (which was recently discontinued oddly enough), they barely fell post GFC. They kind of started to fall in 2014 a little quicker than the Fed balance sheet, but it was minor. There is clearly something wrong in the system beyond the virus, the vaccine will not cure all.
  • JL
    J L.
    22 January 2021 @ 07:14
    Is monetary velocity even a useful and trustworthy barometer any more? I am skeptical. If the official velocity measures do not track activity in the shadow banking system — all of the sources of lending and capital deployment that exist OUTSIDE the traditional system — then velocity measures will become increasingly worthless as the shadow banking system becomes more outsized and important. Consider: M1 monetary velocity has been in a state of decline for more than 13 years (since 2008). M2 monetary velocity has been in a state of decline for more than 20 years (since 1997). You can see both via FRED: https://fred.stlouisfed.org/series/M1V https://fred.stlouisfed.org/series/M2V Does velocity really and truly matter if it's been declining since the mid-1990s (for M2) and more than a decade for M1? Consider the alternative thesis: — Capital flows from Silicon Valley, private equity, SPACs, hedge fund lending, business development corps, and so on, have risen substantially in importance. Official velocity measures, as far as I understand it, do not capture those sources. That would explain why M2 velocity has been falling from 1997 onward. — At the same time, QE has distorted the velocity measure in yet another way, by dramatically increasing the quantity of inert reserves. This is like reducing the volatility in a portfolio by adding cash but not increasing position size. The volatility of the portfolio will get lower and lower the more cash you add, because the ratio of deployed capital to cash gets smaller. It's true that velocity has fallen off a cliff in 2020, but is that because spending slowed down all that dramatically? Or is it more so because the Federal Reserve killed a fly with a sledgehammer, or perhaps a neutron bomb, in terms of dramatically increasing inert reserves? The other elephant in the room that seems to not be addressed at all in these conversations is: What happens when fiscal emphasis really starts to work? We HAVEN'T SEEN the full impacts of fiscal yet — especially when coupled with the power of a full vaccine rollout. After 2008, the crisis response was almost entirely monetary. The majority of the Obama years were actually a period of fiscal TIGHTENING, due to a switch of legislative control in 2010. So the 2010s were a period of monetary looseness trying to counteract fiscal tightness, which is kind of the ideal recipe for equities and asset prices. The monetary looseness juices the market, while fiscal tightness keeps the recovery relatively weak, and corporate profits in recovery plus buybacks meant an investor bonanza. But when the fiscal taps truly get opened, the game potentially changes in a big way — and in ways so big that the Federal Reserve becomes a backseat player. The other problem here is that a very clear and obvious transition point is coming — the full impact of the vaccine rollout. — We are currently early in the vaccine rollout, which of course means consumer spending and credit etc is going to be more depressed than normal. — But post-vaccine rollout, it is reasonable to expect a meaningful phase shift — in consumer spending and activity, and quite possibly in the ignition of inert reserves too, as banks feel more willing to fund business expansion in a high opportunity landscape via small business retreat. And in fact, too, we don't know what will happen to monetary velocity (the traditional kind) AFTER the post-vaccine rollout. It would seem quite reasonable to assume that, in an environment awash in a sea of liquidity (bank reserves) and also awash in opportunity (arid small business landscape), banks will get excited about lending again post-vaccine rollout. This is not hard to see. It is a very reasonable assumption. You can't put it in a spreadsheet necessarily, but it shouldn't be ignored as a factor. The guess said, re inflation, "The market thinks the Fed is starting to generate inflation." No, no, no. Come on. The market thinks that 1) bank reserves will come more into play after the vaccine rollout and 2) the FISCAL side has a real potential to do some heavy lifting on the inflation side. The Fed is NOT a player in either of those factors, other than holding steady. All they have to do is NOT TAPER early. And it just seems wacky to me not to talk more about that — about the FISCAL side. Even all the stuff with the wackiness of the market, the retail traders on Wall Street Bets, SPACs going to the moon and all of that stuff, the massive sector rotation… Pointing out the market craziness is 100% legitimate. We have some real mania activity going on right now in various corners of the market. But why would you pin it on the Fed, and NOT on the fiscal? I mean come on, the asset craziness is FISCAL again. Look at this May CNBC piece showing how the $1,200 stimulus check went heavily into stocks. The U.S. government basically funded the yeeting of hundreds of billions of dollars into speculation: "Research from Envestnet Yodlee, a software and data aggregation company, found that trading was among the more common uses for the $1,200 stimulus cash. That was especially true for people who earn between $35,000 and $75,000 per year, who increased stock trading by 90% in the week after receiving their stimulus checks. Those with annual incomes between $100,000 to $150,000 increased trading by 82%, while people earning more than $150,000 increased that activity by 50%." https://www.cnbc.com/2020/08/24/many-people-invested-their-stimulus-cash-what-to-know-before-you-do.html Fiscal REALLY IS helicopter money (especially when you give checks to people who don't need them). And fiscal also REALLY CAN be inflation-generative in the real economy too. Think what happens when Americans with no money (the ones who need the checks) get the checks. What do they do? They SPEND. The velocity on money given directly to lower-income Americans is HIGH. Fiscal, not Fed. Fiscal, not Fed. It's such a frustrating theme, that has been going on for a while now, I almost want to shout it: FOCUS ON THE FISCAL. WHY DO YOU GUYS TALK SO MUCH ABOUT THE FED AND HARDLY ABOUT THE FISCAL? Honestly, I feel like all this over-emphasis on the Fed is a form of fighting the last war. We are all used to focusing on the Fed because, post-2008 and all through the Obama years, the Fed was the axe, the Fed was doing all the heavy lifting, while the government was limited in its market impacts. But it just ain't that way anymore guys. The FISCAL is what matters now. The Fed only matters to the extent they are willing to not taper, which more or less means they are holding the accelerator to the floor. They aren't the axe. They aren't the variable changing the game. They are monotone impulse and FISCAL is the thing now. Again, I know it's different from the past. Fiscal was a non-entity as a force from 2009-2016. But the fiscal shift — to a whole new driver — actually started in 2017, with Trump's gigantic tax cut. That was the first huge hit of fiscal stimulus (non-monetary) that juiced markets for the first time in decades. And then we got the CARES act response, $2.2 trillion. And then the additional $900 billion or whatever, and now another $1.9 trillion being negotiated, and talk of a $2 trillion infrastructure package after that, and a strong likelihood Yellen will figure out how to work with Powell on funneling money to the states through a gray area backdoor (e.g. loans on such permissive long-dated terms they look like cash). Upshot: THE FED IS NOT THE DRIVER ANY MORE. UPDATE THE MODELS AND FOCUS ON THE ELEPHANT IN THE ROOM, WHICH IS FISCAL. I don't mean to shout. It's just — this habit of ignoring the fiscal is driving me nuts a little. And also consider doing more with shadow banking — please! — because it seems pretty apparent (as noted above) that traditional velocity measures are in danger of becoming irrelevant too.
    • JL
      J L.
      22 January 2021 @ 07:46
      p.s. Traditional velocity measures seem to exclude mortgage lenders too (who would fall under the shadow banking category) which, if you think about it for a minute, is kind of insane. Mortgage refinancing activity accelerated in 2020 at the fastest pace in decades...
    • CK
      C K.
      22 January 2021 @ 10:20
      Good point re: velocity affected by increase in inert reserves. - Velocity with Q42019 GDP and Dec 2019 M2 was at 1.427 - Velocity with Q42020 GDP and Dec 2020 M2 was at 1.103 This is the collapse in velocity we've been hearing about since the start of the crisis. If, we however, compare Q42020 GDP with pre-inert reserve injection (i.e. take M2 in Dec 2019) then velocity would be at 1.383. Sure, a decrease but perhaps not a collapse. Q4 2019 GDP - 21,747.394 (billion) Dec 2019 M2 - 15,307.1 Velocity - 1.427 Q4 2020 GDP - 21,170.252 Dec 2020 M2 - 19,188.2 Velocity - 1.103 Q4 2020 GDP - 21,170.252 Dec 2019 M2 - 15,307.1 Velocity - 1.383 Perhaps we can only make this comparison if we're confident that the increased money supply hasn't positively affected the real economy, which most people seem to agree with. In that case, this could also explain how velocity of M2 had been decreasing since around since the GFC because of QE, which nearly doubled the money supply between 2010-2020 (pre pandemic) during which time GDP grew by about 40%. Is that a valid way of looking at it?
    • JL
      J L.
      22 January 2021 @ 10:43
      @ C.K. I would argue we can draw multiple conclusions from all this: — The greater the influence of the shadow banking system, the more that MV = PQ becomes useless. Impoortant stuff that impacts the true "V" of the economy in aggregate is left out. — If the financial sector is increasingly funding itself via the shadow banking system (which includes mortgage lending), that means velocity is increasingly a meaningless measure relative to financial sector animal spirits and housing-related lending activity. — If the shadow banking system is competing with the traditional banking system (because nonbank lenders are more aggressive than traditional banks), we can expect ever more activity to port over to the shadow banking side, which would slow velocity further. The shadow banking system actually makes reserves more inert, in a way, by providing alternative recourse leverage on more aggressive terms. — The monetary stock may be increasing steadily (M2 has gone down since 1997) because the Fed has been "pushing on a string" in terms of trying to stimulate the real economy and failing. — The Fed may be fooled by paying attention the traditional money stock, while failing to realize that its pushing on a string efforts (which increase the money stock) have meanwhile been helping the shadow banking sector go absolutely crazy. And then the really, really big one: — If traditional velocity is a measure of sluggishness in the real economy, then we can couple that with the observation that the real economy had not seen big fiscal juice for DECADES prior to 2017 (other than the Bush tax cuts). From the late 80s onward it was nearly all monetary. — A TRANSITION SHIFT TO BIG FISCAL CAN CHANGE EVERYTHING. Giving tax cuts to top earners just increases their willingness to buy more target date funds or corporate bonds. Pushing helicopter money into the real economy, and pairing that with a multi-trillion FDR style push across green energy, infrastructure, etcetera and so on, is a whole different ballgame. It's a ballgame we HAVE NOT SEEN in a really, really long time. — At the same time, all those reserves that the Fed pushed into the system are potentially waiting to ignite post-vaccine. We continue to ASSUME that the Fed's efforts to generate inflation haven't worked — and they by and large haven't, except in assets — but again, what happens when you add TRIPLE FISCAL TSUNAMI into the mix? I think we're going to find out, and I think the fiscal aspect is a puzzle piece as big as the Empire State Building, and all these guys who don't talk about it are still missing it — and as such the prospects for inflation are very, VERY real.
    • JL
      J L.
      22 January 2021 @ 11:00
      p.p.s. One other thought: What happens if cash generated by shadow bank lending activity shows up as deposits in the traditional banking system, thus adding to the money stock and decreasing velocity artificially? If something like that is happening, shadow banking activity would distort velocity measures twice over — first by making traditional reserves more inert (via competitive lending activity outside the traditional banking system), and second by making inert reserves look larger (via cash deposits put back into the system). It might not just be the Fed expanding the monetary stock, in other words. Shadow bank activity might also be expanding the quantity of seemingly dormant reserves, making the velocity reading even more of a red herring (and traditional monetary measures even more worthless). MV = PQ = WTF = R.I.P.
    • CK
      C K.
      22 January 2021 @ 11:26
      I agree about the impact of shadow banking, and I'd like to research it more to understand what amounts are involved, how it compares to traditional banking in size, and what part of it affects the real economy (i.e credit creation by non-bank lenders) vs. the asset markets (i.e. hedge funds borrowing to trade with margin). It seems that IMF research estimates that the "velocity of pledged collateral" which "is how money and credit are created in that shadow banking system" is at 2.2 - https://www.realvision.com/shows/the-interview/videos/caitlin-long-and-dr-manmohan-singh-the-real-mechanics-of-monetary-policy-and-the-plumbing-of-the-financial-system Definitely agree with the fiscal side of the argument, and the impact it will have if it is distributed to the right part of the population with a higher propensity to spend, or if it is implemented via CBDCs (Raoul's argument) and a 'spend within X days or lose it' approach.
    • JL
      J L.
      22 January 2021 @ 12:06
      Re shadow banking, yeah I'm curious now too (as to size, impacts etc). Just found this: "“The US has the largest shadow banking system, with assets of $25 trillion in 2007 and $24 trillion in 2010” (Financial Stability Board, 2011, p. 8). According to Pozsar et al. (2010, pp. 7–9), the gross measure of shadow bank liabilities amounted to nearly $22 trillion in June 2007, while total traditional banking liabilities were around $14 trillion. Netted liabilities of shadow banking also were greater in comparison to traditional banking liabilities." I don't think we'll have to wait for CBDCs. The Biden administration knows it has two years to go big (before 2022 midterms). They won't waste time...
    • CK
      C K.
      22 January 2021 @ 16:33
      Nice one, thanks.
  • RK
    Robert K.
    22 January 2021 @ 15:56
    I wish all guest audio quality was this good.
  • RS
    Richard S.
    22 January 2021 @ 11:52
    An excellent presentation. It's amusing to see the FED struggle to meet it's inflation goal. In the high inflation days of the 1980's and 90's, the FED along with government officials purposely rigged standard CPI calculations using hedonic adjustments, etc. to reduce inflation. The goal was to reduce the Federal deficit and cost of living outlays. Everyone knows that CPI inflation (not asset inflation) is much higher than is stated in the official numbers.
  • MH
    Martin H.
    22 January 2021 @ 09:58
    Great interview. Michael Lebowitz is spot on.
  • IL
    Irina L.
    22 January 2021 @ 06:31
    Thanks for the great discussion! Very accurate description of the market.
  • JW
    Jarkko W.
    22 January 2021 @ 06:14
    This was good. All in, itching to get out, well said. Yes, please keep him in rotation.
  • MJ
    Matthew J.
    22 January 2021 @ 05:38
    Great show, guys. I wrote something back in the summer that touches on a similar theme. It's called "Waiting for Inflation" (https://medium.com/@mattdjohnston92/waiting-for-inflation-afc6495c6678).
  • IN
    I N.
    22 January 2021 @ 03:23
    Like. My Videos. Replay - memorize, Replay - memorize. Replay - memorize. ...
  • MC
    Mark C.
    22 January 2021 @ 01:45
    Very good. Thanks.
  • TC
    Tim C.
    22 January 2021 @ 01:31
    Excellent discussion. Extremely honest and pragmatic. This is where we are... I feel the pain of getting stopped out as well, but better to get stopped out and reenter with a CSEP than get hammered... It will be interesting to see how the K-shaped recovery shakes out. As Michael points out, there are mountains of debt built up, both public and private that need to play out. How that plays out and what the Fed and Treasury do will determine what companies get rewarded and what companies get spanked.
  • JD
    James D.
    22 January 2021 @ 01:28
    This is the best description of the current market I have heard and true for some time. The question is timing and the reason quants are so helpful. Excellent discussion!! Please keep Michael in the rotation.
  • JD
    Jeffrey D.
    22 January 2021 @ 01:19
    Great show guys.
  • JS
    Jon S.
    22 January 2021 @ 00:52
    I long for the day of real interest rate price discovery.
  • ND
    Nicole D.
    22 January 2021 @ 00:37
    Excellent, thank you!
  • AD
    Antonio D.
    22 January 2021 @ 00:26
    Everyone sounds like Luke Gromen now. Must be a lot of FFTT subscribers.
  • BK
    Brian K.
    22 January 2021 @ 00:11
    Really top-notch. Don't tell Raoul. It was also like listening to Mike Green on a Deep Dive. Loved the Microsoft example on value overtime periods. Really makes you wonder about the inflation exceptions.
  • JL
    Jake L.
    22 January 2021 @ 00:03
    I thought QE was just a way of expanding a bank's balance sheet (swapping a non fungible bank reserve for a Treasury/MBS). Why is this inflationary, if banks aren't lending? Is this incorrect?
  • TS
    Thomas S.
    22 January 2021 @ 00:01
    Phenomenal conversation!
  • DF
    Douglas F.
    21 January 2021 @ 23:52
    More on Austrian Business Cycle, Minsky/Kindleberger, and speculative bubbles https://cdn.mises.org/Early%20Speculative%20Bubbles%20and%20Increases%20in%20the%20Supply%20of%20Money_2.pdf