ANDREAS STENO: Good afternoon, folks, and welcome to the Real Vision Daily Briefing. I'm Andreas Steno, the senior editor at Real Vision, sending to you live Wednesday, the 27th of July, hot on the heels of the Federal Reserve meeting. Another 75 basis points of hikes but very few commitments to the path ahead. And with me to unpack all of the actions surrounding this Fed meeting is a friend of mine, the founder of 42 Macro, Darius Dale. DD, my man, how are you?
DARIUS DALE: Feeling squeeze today, my friend. How are you doing, brother? How you been?
ANDREAS STENO: A bit the same feeling here to be honest. But Darius, let's get to it. Another 75 basis points. And yet, we had a market reaction with long bond yields dropping initially. And equities, they party like there is no tomorrow. What the hell is going on with that market reaction?
DARIUS DALE: Yeah, so the market reaction was really just a function of the setup coming into the meeting. If you look at our crowding analysis with Trump-- we put out a model out every morning on, the S&P 500 came into today with a 25% volatility risk premium on a very near term basis so that effectively got all washed out just really with Powell offering a sort of a pivot, if you will, towards open-ended guidance.
Now, let me be very clear. This is not an effectual policy pivot. But it was a pivot to focusing on more data dependency as opposed to providing a more clear path to guidance. He said, quote, "We think it's time to go in a meeting-to-meeting basis and not provide the kind of clear guidance we provided on the way to neutral. So markets took that and said, hey, look, let me get rid of this near-term implied volatility risk premium. The event risk is now behind us."
ANDREAS STENO: Yeah, and it almost sounded like he received the notes from Christine Lagarde from the European Central Bank last week. She used the exact same wording, we're going to take this meeting by meeting.
Darius, I wanted to play a sound bite for you. And it's from a discussion you had live yesterday on the Real Vision platform ahead of the meeting today. So let's listen to the soundbite and continue the discussion afterwards.
DARIUS DALE: Yeah, so I mean, just go back to their framework, right? We got to put ourselves in their shoes, and we try to evaluate the decisions that these folks will make at any given interval, right? Like, they have this framework. We can all debate and discuss it about neutral interest rates and whatever the neutral interest rate of the economy is. And their estimation, at least, according to Powell 2 meetings ago, was that levels are right around 22.5%.
And so there's been a lot of talk amongst policymakers, Bullard in particular, about getting to neutral really quickly, front-end loading the rate hikes, and then particularly potentially being able to pause at that moment in time. So I think 75 basis points is priced into futures markets. Why not just take the shot and get it over with?
ANDREAS STENO: So Darius, you basically nailed the meeting today in the live discussion yesterday. But still, you seemed a bit surprised by the market reaction. What's changed?
DARIUS DALE: Oh, well, no, I wouldn't necessarily say I'm surprised by the market of that reaction positioned poorly for the market reaction to be clear, but certainly not surprised. I mean, any time you go into any event, particularly 1 of this consequence with a 25% volatility risk premium and something as massive as the SPI, you're going to get that wash out, an event vol.
It takes a hell of a lot from a hawkish surprise perspective in order for that not to catalyze an unwind. But I'd be very clear that you might not necessarily want to chase this. You go back to the last 2 FOMC meetings, which obviously also had a build up in event vol into the catalyst.
On May 4, we were up 3% on the FOMC meeting as that volatility risk premia got decayed. But they were down 3.6% the next day. Similar dynamics happened in last FOMC meeting in mid-June. On June 15, we were up 1.5% on the day of the FOMC. Then we ultimately decayed -3.3% on the following day.
So I just want to make sure that everyone's aware that it's not necessarily anything that Powell said or did that is creating a medium-term path for more sanguine markets. This a lot-- has a lot more to do with near-term volatility premium near-term positioning in the volatility markets.
ANDREAS STENO: You mentioned initially that Powell basically decided to end forward guidance today. The Fed will take a meeting-by-meeting approach to decisions now. And my own opinion towards the discussion of the end of forward guidance is that it could actually end up increasing volatility. What do you make of that discussion?
DARIUS DALE: Yeah, I mean, it's likely to end up increasing volatility in the rate space. But the reality is-- I mean, I think that when you remove forward guidance from the perspective of policymakers, now, we are on our own as market participants to guess the likely outcome both with respect to the economy, but also in terms of how the economy feeds back into policy.
So this is we're heading into a period where you're going to need to have good forecasts of what's likely to happen on growth and what's likely to happen on inflation in order to get the Fed reaction function right.
ANDREAS STENO: If we look at the Fed funds rate after today, 2 and 1/2% is now the ceiling for the Fed funds rate. And Powell basically said that this is now around the neutral range for the Fed funds rate. If we then look ahead, labor markets will be a deciding factor for the Federal Reserve. And inflation will be a deciding factor for the Federal Reserve. What do you make of the labor market and the inflation outlook and then ultimately the outlook for Federal Reserve hikes?
DARIUS DALE: Yeah, so this is something I really talked in great detail with yesterday, my friends, Steven Van Metre and Jeff Snider on the Real Vision platform. If the Fed is now shifting to a back towards its dual mandate, you have to realize that its dual mandate is very lagged with respect to the financial markets.
It's obviously got a maximum employment mandate and then the price stability mandate, which it's been the primary focus throughout the year to date. So I sent a couple of charts to you, Brian. The first chart is Slide 82 from our most recent macroscouting report presentation, which we put out monthly.
The title of the slide is The Labor Market is Too Strong for the Fed to Stop Tightening. And what this chart shows in the upper panel is the JOLTS job opening-- total job openings. The red dotted line just shows where the most recent print is relative to the overall time series as far back as we have the data.
The next dotted line, or the next panel shows the quits rate at 3.1%. Obviously still extremely elevated relative to where we have the data. And then lastly, the employment cost index at 4.5%. And the most recent print is as high as we've ever seen in the time series.
So you look at those 3 factors together. And then you take that in conjunction on Slide 83. Brian put up that bar chart, Slide 83. You take the level of the activity in the labor market with respect to how tight it is.
But then you also take the momentum in the labor market what I'm showing in this chart, the light blue bars in this chart of the 2015 to 2019 trend of the trend growth rate of private of these various indicators. The gray bar is the most recent month, and the blue bars are the most is the-- I'm sorry, the gray bar is the penultimate month. And the blue bars is the most recent month.
And as you can see in private payrolls, hourly earnings, that's the second cluster bar. And the fourth cluster bar is private sector aggregate labor income. We are literally growing at a rate through the June jobs report at a rate that's double the 2015 to 2019 trend in these statistics.
So not only is the labor market extremely tight just from a levels perspective. The momentum is incredibly robust. And this is something that in our opinion, because the labor market is a lagging indicator, both the GDP cycle but also obviously the market cycle, this likely means that if they're focused on employment, they're going to overtighten and make the recession that we're likely to experience deeper and more protracted.
ANDREAS STENO: The question after to date, Darius, is how far we can go above the neutral rate? And I think we can bring up a chart on the eurodollar futures pricing indicating that the market expects the Federal Reserve to go, say, 90 to 100 basis points above neutral. Is that too much in your opinion? Or what do you expect for the path ahead?
DARIUS DALE: Yeah, and I'd be the first one to tell you that, like, this concept of neutral interest rates is a very wonky loose concept. You only really know it after the fact. I'm not going to throw a estimate of what the ultimate level that we can go past neutral is. But the reality is the markets are going to tell us. And this is the problem with looking at economic statistics to guide policy, right?
The policy works on long and variable lags for their own guidance, not mine, with respect to its impact on the economy. And so if they're looking at the most lagging indicators in the economy, they're naturally going to set themselves up for creating a worse outcome economically than they otherwise would.
And I'm not saying that clearly Powell gave us some guidance on recession, right? He got a bunch of questions on recession. And I thought 1 statement he made was probably, in my opinion, the key takeaway of the meeting outside of the shift to removal for guidance which was we're not trying to have a recession, and we don't think we have to.
We know that the path is narrow based on events that are outside of our control, and it may narrow further. But restoring price stability is just something that we just have to do. And to me, it says that, hey, look, we understand that there's recession risk. But push comes to shove, unless things are all hell is breaking loose in financial markets from a financial condition standpoint, we're probably not going to be able to really materially pivot, certainly aren't going to be able to start cutting rates and doing QE as quickly as some of the market hopes.
ANDREAS STENO: One of the widely debated recession indicators is the shape of the yield curve. And we have an increasing amount of tenors that are now inverted on the dollar yield curve. We have $0.02 in deeply inverted territory. We even have a version of the Fed favorite. The spread between the 3-month rate and then the 3-month rate in 18 months from now being inverted as of now if you look at the Fed funds future. So, I mean, there is how many tenors will have to invert before Powell changes his mind?
DARIUS DALE: Yeah, so this is the great question, man. And so this goes back to some of the things that we're talking about in yesterday's discussion, which is we are as market participants or of-- it's our job to make money in financial markets. In order to do that, you have to have a view. We have to have a position. And ultimately that position needs to be rewarded by the market.
For the Fed, the Fed is operating on a completely different set of objectives, right? The Fed is trying to achieve economic outcomes. So the Fed can't look at the yield curve, which, by the way, is influencing with both the size of its balance sheet and the change in its balance sheet and interest rate policy as a indicator for what it should also do from a policy standpoint.
The Fed has to react to economic statistics and ultimately gauge the-- based on forecasting tools. There's 1,000 PhD economists at the Fed that ostensibly what they're doing but clearly have not in recent years. But anyway, I digress. It's their job to look at economic statistics forecast-- those economic statistics in order to get them into the right policy setting. And sometimes, they're right. Sometimes they're wrong. And obviously, they were so wrong last year that it's leading to them to maintain this hawkish bias and be well into a growth slowdown.
In our opinion, if the Fed was looking as a acting as an investor, they would have stopped hiking interest rates a while ago. They would have stopped doing QT a while ago because we've already sown the seeds of a pretty significant slowdown already if you look at the leading indicators of growth.
ANDREAS STENO: Powell received a bunch of questions on the recession risks today at the press conference. And at least initially during the first couple of questions, he kept referring back to inflation when he was questioned about the recession risks. Do you think inflation matters more than the potential recession risk for the Federal Reserve at this juncture?
DARIUS DALE: Yeah, without question. I mean, he said it verbatim. He said that we do see that there is the risk of doing too much, i.e., pushing the economy into a deeper slowdown than it otherwise needs to have. But he also said the risk of doing too little is too great. I mean, that's as simple as a non-binary or simple and binary as it can possibly be.
And then the 1 thing that also was reiterated from the last press conference was this concept that labor market there, the price, the maximum employment mandate is conditional on their price stability mandate, which means they don't believe that they can achieve maximum employment anyway if price stability features are not met.
So at the end of the day, this meeting is a lot less about what is the Fed telling us they're going to do and more about pushing the responsibility back to us as investors to generate forecasts, have views, and put positions on in markets. And you either have a view that we're going to have a mild recession, and it's priced in. Or you have a view that every incremental step of tightening these people do beyond let's call it May or June is going to make whatever recession we have deeper and more protracted. And that's certainly our view.
ANDREAS STENO: If we take a step back and look at some of the other questions at the press conference, some of them were related to the debate on the price target of the Federal Reserve. Powell received the question on the target variable being the PCE price index, which is currently growing at clearly less rapid levels than the consumer price index. Powell kept reiterating that PCE is the actual target variable, but it wasn't a completely crystal clear answer. What do you make of that debate with CPI growing at such a fast pace compared to the actual target variable?
DARIUS DALE: Yeah, and I thought that was interesting. He didn't say anything definitive. So it's not clear that we should as investors change the perception of the Fed's reaction function based on this particular discussion. We have a couple of charts in there that contextualize what's happening in inflation.
If you go to Slide 85, Brian, where we show core CPI, core goods CPI and core services CPI, similar analysis is the prior bar chart, which is the latest 3-month annualized inflation rate is in the blue. And the penultimate is in the gray. And as you can see, core CPI pressures are accelerating on a momentum basis.
Again, this is not your arrear. This is 3-month annualized. We are building momentum sequentially on core CPI, core goods CPI, and core services CPI which is also the fastest. It's growing at the fastest rate we've seen since August of 1990. But that's not the issue as it relates to this interplay between CPI and core PCE.
The interplay is on the next chart, Brian, on Slide 87 where we show median CPI, sticky CPI, and core PCE. Median CPI on a 3-month annualized rate of change basis is growing at the fastest rate we've ever seen. So it's telling you that we have a very significant broadening of inflation pressures that we have never seen before. It's not just energy, food, or housing. It's literally everything in the dang index certainly relative to the time series.
And then sticky CPI, that accelerated in June to the fastest rate we've seen since August '82. So the reason I highlight these 2 particular indicators is because those are the things that are most correlated with core PCE which is the files say that's not their target objective. But the reality that it's definitely the thing that guides policy the most as it relates to their longer-term structural views on the terminal Fed funds rate, et cetera. So whether it's P headline CPI or core PCE, all we is that these things are actually getting worse, not better.
ANDREAS STENO: If we look at the spread between the median print of the PC Brian price index and the median print in the CPI index, that spread is basically more or less all time wide. And in history, we've only observed such big spreads right ahead of material economic slowdown. Do you think this is an indicator that the slowdown is right ahead of us again?
DARIUS DALE: Yeah, I mean, [LAUGHS]. So I mean-- so let me be very clear. Like, we came into the year. We said something at the beginning of the year that ultimately became consensus, which is people aren't talking about a recession enough. They're not talking about the US economy growing below trend as opposed to above trend.
Go back to January. The consensus view was that growth will be well above trend. Recession was at best, a 2024 event. Obviously now, we're talking about 1 that may materialize by the end of this year. The second thing we said going back to the early part of the year was we are likely to have an earnings recession.
I think that the jury-- clearly, Q2 earnings have been generally well received. But just from an outlook perspective, if we get the kind of growth slowdown that we have projected in our models throughout Q3 and Q4, we will have an earnings recession and potentially pretty deep earnings recession. So to answer your question as a long-winded answer, my friend.
But yeah, no, it's very much in the cards. We already have a significant slowing of growth baked into the cake based on the shock we've seen in real interest rates. And we can see a lot of this in the leading indicators whether you look at the PMIs, whether you look at the consumer confidence data. So it's already happening. And it's just going to get worse every time the Fed hikes rates again, every time that the balance sheet continues to contract.
ANDREAS STENO: Brian, we can bring up a model on the