Space Summary
The Twitter Space Head of Macro LIVE: How Many Fed Cuts and What’s the Impact? hosted by j_fishback. The Head of Macro LIVE Twitter space delved into the potential consequences of Federal Reserve cuts on various sectors, offering valuable insights into investment strategies and economic landscapes. Discussed topics included the impact of rate cuts, importance of macroeconomic indicators, risk management strategies, and adapting to market uncertainties. With a focus on geopolitical influences and long-term planning, the space provided a comprehensive view for investors navigating volatile markets.
For more spaces, visit the Alpha Group page.
Questions
Q: How do Federal Reserve rate cuts impact the stock market?
A: Rate cuts can lead to increased borrowing and spending, potentially boosting stock prices and market sentiment.
Q: What are the key considerations for investors during economic uncertainties?
A: Diversification, risk management, and staying updated on market trends are crucial for investors.
Q: How can geopolitical events influence investment decisions?
A: Geopolitical events can create market volatility and impact asset prices, requiring a careful assessment by investors.
Q: Why is it important to understand macroeconomic indicators for investors?
A: Macro indicators provide insights into economic health, guiding investment decisions and risk assessment.
Q: What strategies can investors adopt to mitigate risks in volatile markets?
A: Strategies include diversification, asset allocation, and regular monitoring of portfolio performance.
Q: How can investors stay informed about changing market conditions?
A: Utilizing resources like financial news, analyst reports, and economic data can help investors stay informed and make better decisions.
Q: What role does adaptability play in successful investing?
A: Being adaptable allows investors to adjust to changing market dynamics and optimize their portfolios for better returns.
Q: How do investment professionals forecast economic trends?
A: Forecasting involves analyzing historical data, market trends, and socio-political developments to predict future economic conditions.
Q: Why is risk management essential in investment portfolios?
A: Managing risk reduces potential losses and ensures that portfolios are better positioned to withstand market fluctuations.
Q: How do market uncertainties impact long-term investment strategies?
A: Uncertainties may require adjustments in long-term strategies, emphasizing the need for flexibility and risk assessment in investment planning.
Highlights
Time: 00:15:43
Impact of Fed Rate Cuts on Stock Market Analyzing how rate cuts influence stock prices and market performance.
Time: 00:30:50
Strategies for Portfolio Diversification Exploring ways to diversify portfolios and manage risk effectively.
Time: 00:45:22
Geopolitical Events and Market Volatility Understanding how global events can create market fluctuations and investment challenges.
Time: 01:00:17
Forecasting Economic Trends for Investors Insights into predicting economic trends and their implications for investor decision-making.
Time: 01:15:33
The Role of Adaptability in Investing Adapting to changing market conditions and optimizing investment strategies.
Time: 01:30:55
Risk Management Strategies for Investors Managing risks effectively to protect portfolios and enhance long-term returns.
Time: 01:45:40
Navigating Market Uncertainties Tips for navigating through market uncertainties and economic challenges.
Time: 02:00:22
Insights on Economic Indicators Understanding the significance of macroeconomic indicators for investment decisions.
Time: 02:15:18
Investment Opportunities in Volatile Markets Exploring opportunities and risks in volatile market conditions.
Time: 02:30:10
Long-Term Investment Strategies Strategies for building resilient long-term investment portfolios.
Time: 02:45:25
Advising in Uncertain Economic Times Guidance on investment decisions during economic uncertainties and market fluctuations.
Key Takeaways
- Discussions on the potential impact of Federal Reserve rate cuts on markets and sectors.
- Insights into investment strategies during uncertain economic times.
- Understanding the role of the Federal Reserve in shaping economic policies and market conditions.
- Exploration of macroeconomic indicators and their significance for investors.
- Importance of staying informed and adaptable in the ever-changing financial landscape.
- Considerations for portfolio diversification and risk management in volatile markets.
- Tips for forecasting economic trends and making informed investment decisions.
- Implications of geopolitical events on global markets and investment opportunities.
- Balancing risk and return in investment portfolios amidst economic uncertainties.
- Strategies for navigating through market volatilities and uncertainties.
Behind the Mic
Starting the Conversation
Bill, Joseph, you guys ready? Hey. Yep. All right. Can hear you fine. Let's just stay unmuted so we can keep it an open conversation. We'll take speaker requests a little bit later. And questions. Good morning to everyone joining us for this important discussion right after Fed Chair Powell has spoken at Jackson Hole. The headlines are unmistakable, which seems to be the operative word of the day. Quote, the time has come for politics.
Technical Issues with the Call
Hey, I don't hear anything. James, is your mic on? Yeah. These spaces sometimes can be finicky. James, you there? You can hear me, right? Just. Okay, now I can. Now you're back. Yeah. There we go. Perfect. Perfect. So just to start off, initial reactions, Joseph, you've been writing a lot about Fed policy, the transmission mechanism. I'm sure we'll talk as well about Vice President Harris's economic plans and the potential impact on inflation in the economy. What are your first reactions to chair Powell's speech this morning?
Reactions to Powell's Speech
Well, first off, I think that this was very much an official pivot. So this is much stands in contrast to what he did a couple years ago, stand up and said that were going to raise rates, there would be some pain. But now it's very clear that Chirpao has officially pivoted towards the rate cutting cycle and will have rate cuts in September, although he did not commit or comment on the pace or the extent that's going to be data dependent. So what really stood out to me was his emphasis that now his two mandates, both inflation and unemployment, are basically in balance, with a notable mention that he does not seek or welcome further weakening in the labor market. And this stuff, I think, was already well priced into the markets.
Market Reactions After the Speech
If you look at short term interest rates, I think they priced in a little bit more cuts. So this should not have surprised market at all. But of course, we do see a big reaction in equities in commodities, I'm sorry. And currencies. Yeah, that's exactly right, Joseph. I mean, where we are right now, fully priced, obviously for 25 basis points next month, about a 25% chance of a 50 basis point move. We've come a long way, right, Phil? From where were at the beginning of the month, August 5, when the market was credibly pricing a 75 basis point move with the Vixen above 65. Initial read of how markets were positioned coming into this and where we stand now, Phil?
Market's Response to Powell's Remarks
Yeah, I mean, the market had a huge reaction during the speech, after the speech still looks pretty strong right now. And something that I was picking up on was I think yesterday we saw 75% chance on CME for a quarter point cut. And that's actually gone down to 67, which is like a maybe a small notable move. And that means a 50 basis point odds went from, I think like 23% to 32%. So I noticed that. And really the question I was left with was, Joseph, you mentioned this already. What is the pace going to be of these cuts? And I'm wondering, is it going to be, I assume it's going to be slower than the pace, the rate hikes. But what was your guys read on that?
Discussion on Rate Cuts
Yeah, I think to Joseph Ford. I think it was notable, Phil, to that point is we heard from Boston fed President Collins as well as Philadelphia president Harker. They mentioned this term gradual, these gradual easing cycle. Gradual cuts, which would suggest quantitatively 25 basis points as opposed to 50 or even 75. The word gradual didn't come up in Powell's speech. I wouldn't read too much into that. The bigger date on the agenda now is September 6. That's going to be the August employment report we're going to see. Was that big miss from the July report that triggered the sell off and triggered real expectations of 75 earlier this month. Was that a one off? So I view the lack of gradual as Fed share Powell preserving optionality going into this important jobs report. Curious, Joseph, how you see it.
Employment Reports and Economic Context
No, I agree as well. I think he didn't make any comment on the pace or extent of cuts because he honestly doesn't know it's going to depend upon the upcoming jobs report a lot. I think we want to know if that sudden spike in the unemployment rate to 4.3% last month, was it some kind of aberration, as people are claiming, or does it really just reflect a sudden weakness in the labor market? So a couple of things to keep in mind as we think about this, though, is that from the Fed's perspective, they think that policy is very restrictive, right? So they think that the neutral rate maybe, let's say two, 3%, or right now we're at 5.5% in nominal Fed funds. And another thing to think about is that Fed usually likes to act very slowly and methodologically.
Pacing of Fed's Rate Cuts
So having a sudden 50 basis point cut really wouldn't make sense usually, unless you had sudden weakening, a very unexpected weakening in the market. Now, we know that when in the past, when were close to the zero lower bound, Fed officials would say that we should go big because we're close to lower bound and because we're a close lower bound we can't cut a lot. So when we cut, we want to be able to surprise in markets now, we're a lot higher than we are before. So there's probably less of an impetus to have these big sudden cuts. But I agree with James. It's all going to come down to the labor market. If it really just continues to have a surprise to the downside, higher rise in the unemployment rate.
Expectations for Future Rate Cuts
We could expect pretty big cuts. Right now the market is pricing at 100 basis points by the end of this year. Market has a tendency, as we've seen over the past, to price in more cuts than the Fed delivers. Recall in January were pricing in seven cuts. This year. So far we've had none. So the market has that. So let's watch very closely what happens with the September jobs report. That's exactly right, Joseph. And it's incredible. There's obviously been price volatility. That's par for the course. But it seems like the narrative volatility has been unbelievably high from where were coming into the year.
Trends Over the Current Year
At this point in January this year, the market was saying the Fed funds rate would be four and a half percent. Obviously, the fed funds rate is not four and a half percent, it's 5.3%. And so the narratives keep changing. What was the narrative two weeks ago that the Jeremy Siegels of the world wonde wanted 75 basis point emergency rate cut, and there were some actual people behind that with how the market was pricing things? I think to Joseph's point as well, is that the fact that we're so far from the zero lower bound, that is zero rates, that gives them some move, some optionality to say, look, we don't have to be as aggressive, but I think that, Phil, you've written about this recently.
Interpretations of Economic Reports
Was this the one off report. But I think in a more macro sense, there have been folks who have written off the rise unemployment, saying that this has been supply driven, that this has not been the result of elevated layoffs, this has not been the result of a real, genuine economic downturn. But look at what Powell says, and I'm just quoting here from this morning's speech, quote, most of that increase has come over the past six months, referring to that employment rate. So far, rising unemployment has not been the result of elevated layoffs as is typically the case in an economic downturn.
Continued Analysis of Unemployment Trends
Rather, the increase mainly reflects a substantial increase in the supply of workers. We know that to be immigration. That's my commentary. And a slowdown from the previous frantic pace of hiring even. So, here's the but. The cooling in the labor market conditions is unmistakable. And I learned from my time, Phil and Joseph, in high school debate that if you have the word but in a sentence, everything before the but is irrelevant. Your beautiful but, your smart but. You were the head of macro but. And so discount that. Put that in context. Are we seeing that Powell really has genuinely pivoted to the employment side of the mandate? Joseph I think he has.
Changes in the Fed's Composition
And one way that I look at this is, you know that the FOMC, the people who make the decisions at the Fed, they change over time. And so the values of the fed, how they weigh that balance between full employment and price stability also changes over time. So one thing that I've noted, when you look at the composition of the FOMC, there's been some big changes. President Biden was able to make a lot of appointments. And the people who are appointed on the FOMC now, if you look at their backgrounds, most of them, they don't really have much of a background in, say, macroeconomics, but they tend to be have a background in labor economics.
Pro Labor Perspectives in the FOMC
So that tells me that these people are going to weigh the unemployment mandate a lot more than the price stability mandate. So I think that change in the composition of the FOMC is going to structurally make it more pro labor, and that argues for easier monetary policy. Now, this is now the Fed. Again, a lot of people, we've heard some hawks talk about what they would like to do and so forth. But I think that the tendency, though, looking across just the composition, is a more dovish fed. And so I think it has really just shifted towards more of an emphasis on unemployment than price.
Current Inflation Measures
And to be clear, if you look at the PCE data now, the Fed, there are many different measures of inflation, PPI, CPI and so forth. The Fed cares about PCE, specifically core PC, that's just a little bit above 2%. So it does make sense to care more about labor unemployment than inflation right now. That's right. I have a question, Joseph. Do you think that any part of Powell's speech today, was he on purpose not mentioning the jobs revisions this week, or do you think he was just trying to hint at it by saying, but what was your take there?
Revisions and Economic Data
Well, you know, I don't really know how they perceive that the revision data is noisy. There are revisions all the time, to GDP, to everything. He did not mention it specifically like you noted, but he did in many ways show that the labor market was softening.
Revisions in Jobs Data Discussion
And so I imagine that revision in jobs data could play into that. But I'm not in the weeds enough as to how this data actually is calculated to be able to comment intelligently on it. And I would note to your question, Phil, that I'm just looking at the transcript from the June press conference, the one two months back, Powell says you have payroll jobs still coming in strong, even though, you know, there's an argument that they may be a bit overstated. They're still strong. And so to some extent, a lot of this was already anticipated. Right. You look at the Bloomberg consensus was for a 750,000 negative revision. And so certainly the headlines have run with it. Certainly President Trump, who I think would benefit obviously from this weak data, has run with it. But this was not a real surprise for a Fed that for the past several months, including the chair, has talked about the risk that the job numbers are overstated. And even though they were overstated, they're still well above the breakeven rate. That would be consistent with keeping unemployment, all else equal, unchanged.
Employment Data Insights
James, to your point, I would also mention that from the Fed minutes we got this week, it was noted that many people on the FOMC were thinking that maybe the unemployment data was overstated. So the employment date was overstated. So maybe unemployment rate was higher than expected. So that would imply that there were people on the Fed, many people who were thinking that we would have a big revision like we did. Yeah, that's right. That's right. So how do you guys think about how this flows through to risk assets going forward? So it looks like the equity markets are loving it, currencies, dollars weakening a lot. Do you think this is something that will continue or this is something that is just maybe an overreaction? I mean, my read on this right now, the stock reaction was so immediate and so fast, it'll probably fade a teeny bit. But I think generally, if we're getting a series of rate cuts, that's exactly what markets have been expecting for a year now. That's pretty, I think that's, what else could it mean other than bullish? Because this is what everyone's been wanting and expecting for so long.
Market Reactions and Rate Cuts
Finally, we're getting the signal that we're getting it. You know, how other way would you read this? Well, first off, I think James is having some connection difficulties. So I don't know. Oh, I'm here. Okay. Okay. Apologies. From my screen it looks like you're okay. So, you know, I was, I've been wondering maybe this would be more of a sell the news event because so many people have been positioning for this rate cut cycle. And I think the truth is that we do have a slowing economy. Now, usually I would look at this at a slowing economy. Rate cuts bullish. But the stock market, as we know, changes its mind from time to time. In the past, sometimes good news is good news, sometimes good news is bad news. It seems like we're moving into a regime where the market is becoming more concerned about recession. And so a slowing economy, I think, would outweigh the market positive impacts of rate cuts.
Concerns about Economic Trends
I mean, that's kind of the sense that I got from the last drops report where we had a big spike in the unemployment rate and the market didn't like that. So I'm not really sure if this is going to be as bullish as the market seems to be pricing right now. Yeah, I think that's right, Joseph. And to Phil's point earlier, we obviously got an immediate move higher in stocks. I think it's important to look at obviously the differentiation. Right. So to your point, Joseph, what the S and P 500 does in the wake of rate cuts and them potentially being triggered by real economic weakness is very different than what the Russell would do as it's more cyclically focused, more sensitive to real economic conditions. The capex plans for folks buying Nvidia GPU's two, three years down the line are unlikely to be affected by a quarter or two of negative GDP growth.
Market Reaction to Job Reports
But let's also not forget that the market reaction we're seeing in rates today is muted by the fact that we've already moved 50 basis points lower in the two year treasury yield since the end of July. And so I think it's kind of underwhelming. But in the sense that a lot of this move was front loaded by that weak July jobs report we got in early August. It was front loaded by the VIX going to 65. And although it's come back, the rates market is still right where it was when those moves were largely priced in. Right now we're at 390 on the two year, not far from the lows we achieved in early August during that market episode. And so I think that this is not as much of a surprise since the Fed has been guiding toward it. And again, we're dealing with the data dependent Fed guys. And so the data has been moving, the market has been moving the Fed this way.
Consequences of Economic Data
And now it was really about, I think, Powell marking to market to what the folks had already come around to seeing which is September is the beginning? I guess the question now is what does that pace look like and what are the conditional probabilities there? Joseph, is it September and then kind of a foregone conclusion for that November cut or what are we thinking about there? So I continue to think that we're going to have 25 basis point cuts every meeting for the remainder of this year for 75 total. But it's going to depend a lot on the job market if we do have just ongoing deterioration in the labor market, unemployment rate continues to rise. I think we could have a lot more than even the 100 basis point priced in right now. So it's really, that September jobs report is going to be really important, I think, in determining the trajectory of Fed cuts.
Expectations on Future Rate Cuts
Yeah, agree completely. Agree completely. And Phil, any thoughts on that? On the pace? Yeah, I think the gradual pace is going to be what we're going to see, 25 basis point cuts. My question now is really back to what you guys were mentioning about equity is reacting to negative economic data. Do you think that let's say we get one or two worse job reports or even if we get a spike inflation, what's the market response there? Even if the Fed continues to signal we're going to use everything in our power to ease monetary policy? I would say, Phil, that their reaction function, which is academic speak for how the Fed reacts to economic developments, is very much skewed toward the labor market and not the inflation side.
Focus on Labor Market
And so let's look at what Powell said in late July. At the meeting. At the press conference, he said we are data dependent, not data point dependent. Now when I wrote earlier this month on the Azoria substack, that meant that they would largely look through the weakness and wouldn't use that to justify a 50 basis point unless it was validated by more weakness in the jobs market, by let's say an August report that would be weak is the same reason they would look through an inflation print that might be higher between now and the September meeting or later down the line. They have to look at the totality of it. And the totality of it is headline CPI was 9% and today it's two and a half percent, 2.6%. So we have come a long way and we very much to Joseph Point, are skewing toward of the labor market as the primary focus of the Fed.
Powell's Perspective on Inflation and Employment
I want to read the sentence from Powell's speech as well. Quote, let's see where it is here, that it's on the downside risks here. Quote the upside risks to inflation have diminished and the downside risks to employment have increased. And so in the event were to your question, to your hypothetical phil, to see a stronger, hotter than expected inflation number, it would be in the totality, in the context, as Vice President Harris says, the context of all of which we live, in the context of a string of weaker numbers. You would really have to see consistent, hotter, and then also the spreading out, not just isolated to certain parts of the economy, the actual diffusion of inflation.
Anticipating Economic Scenarios
To see that upend this plan. I agree with Joseph. I think we're going to get three cuts this year, 25 basis points, with the risk of a 50 conditional on the labor market really falling out of bed and kind of validating and furthering that weakness that we saw in July. 1 thing that's really standing out to me is the dollar, how it's been weakening significantly. When I look at the euro, USD or especially the pound, it looks like they're like going parabolically upwards, like the dollar is weakening significantly against them. Do you guys have any thoughts on that? It seems it really stands out to me.
Interest Rate Impact on Currency
Yeah. My initial thoughts on that is that you and I and Phil know this, and I think most of the listeners know this, that g ten currency rates in particular are a function of interest rate differentials. And so it's not a coincidence that we've seen the market price over 200 basis points of rate cuts between now and the end of 2025. And the euro appreciate the yen, appreciate the pound, appreciate against that backdrop. And so in many ways, it looks like the euro and these other currencies are trading on the back of what the markets expect the Fed to do.
Future Projections and Dollar Strength
And so, again, to throw the question back at you, Joseph, is if we don't see that Fed path as priced by the market, which is pretty dovish all the way to 2025, does that reconcile into a stronger dollar over that time period? So when I look at the dollar, obviously interest rate differentials play a big role. But I think another thing is also that when you have a period of, let's say, economic distress, oftentimes the dollar also gets a bid as well. So even though that we're pricing a lot of cuts, I think other countries are pricing in cuts as well. If I think we've the less.
Interest Rate Comparisons
Of course, if the short term interest rate path here is going to be a bit higher than market is pricing, and that's dollar positive, it also seems that the US is outperforming other countries. And so I think there's a good chance that the interest rate differentials between the US and other developed countries remains wide. So it's surprising to me that the dollar is getting sold so aggressively here.
Discussion on Global Currency Trends
And part of it. I agree. With momentum as well. I agree. Yeah, I agree. And I think that's the. I'm curious, the stuff that you're writing about, Phil, international developments, how that might play into the currency moves we've seen. Yeah. You mean like what geopolitics could mean for currencies? Yeah, yeah, I mean, I think that's. There's always a risk, of course, of geopolitics coming into play, but I think this really is a interest rate narrative here.
Fed's Timing on Rate Cuts
The one question I've been thinking about today is, does anything, in Powell's speech to Joseph or James, either of you guys, is there any acknowledgement that the Fed has been late on cutting? No, I don't see any of that. I mean, if they thought they were late, they would have cut it already, right? Yeah. I mean, was there a. I don't know. I thought the jobs revision this week was sort of one data point that suggested they were late. And I wrote about that this week as well.
Perception of the Fed's Actions
Is. I mean. Yeah. Was the Fed late?
Market Anticipations and Fed Actions
Is the Fed late still? So I think it's important to think about this through the lens of Powell. So Powell thinks about notes that one of the reasons why there are fewer lags when it comes to monetary policy is because the market anticipates far in advance what the Fed will do. This is very different from, say, the era of greenspan. So right now, the market is anticipating a whole bunch of cuts, probably more than what the Fed would deliver. So in a sense, the Fed has already eased because rates have come down a lot. So I don't think they would think themselves as being late. In fact, I would say that maybe there's more of a chance of them having the market easing too much for them already. Unless, of course, you think 100 basis points by the end of this year is the reasonable thing to do.
Current Mortgage Rates and Economic Impact
And to Joseph's point, I mean, look at the 30 year fixed rate mortgage, right? On bank rate at the end of July it was 7.15%, 7.15, and now it's 690. So we've already seen that easing come through the market moving consistently with the rate that 30 year mortgages are priced off of, which is the ten year treasury yield. You're already getting that easing. It's not as if everything is tied to the overnight Fed funds rate. Right. And the second they cut all of a sudden people start jumping up and down in the streets and start going. I think the bigger question here, before we open it up to questioning from the listeners, is what impact will this have on the real economy? Let's not forget that for all this talk about 7% and 8% mortgages earlier this year, the average homeowner in America is locked in at 3.6%. The average effective mortgage rate is 3.6%.
Retail Sales and Economic Performance
We got retail sales blow it out of the water. We've got claims, jobless claims, suggesting that, no, the labor market isn't great, but it is decent. We had second quarter GDP at 2.8. We have third quarter Atlanta Fed showing just above 2%. The markets at all time highs. And this is against a backdrop where you have two candidates that have proposed policies, one far more inflationary than the other. And so I guess before we open it up, just last questions, is real impact on the economy? The Fed delivers the 75 basis points that we all seem to suggest is coming. What does this actually do for the real economy? Joseph?
Fed's Impact on the Economy
You know, looking back the past couple of years, I think one thing that we should take away is that the Fed's impact on the real economy is not as strong as we all thought. Definitely have a very strong impact on financial assets. But let's rewind a couple of years. So I think a couple of years ago, everyone said that when the Fed, if the Fed were to hike rates to, say 5.5%, we'd have a tremendous recession, unemployment rate would surge, but none of that happened. We've had interest rates pretty high. And if you look at, say, interest rate sensitive sectors like homebuilders, well, home builders stock still doing very well, construction, employment still doing really well. And so it seems like the takeaway is that monetary policy, that channel of transmission, isn't as strong as we all thought it was.
Outlook on Rate Cuts and Policy Impacts
So as we move towards rate cuts, I wonder if maybe the same thing would also be the same thing on the way down. I think that as mortgage rates come down, we could see more of a stimulative effect on housing and so forth. It's unlikely that where they would come down from to, say, five or 4%. So maybe that impact is not going to be that large either. I think the bigger impact on the real economy, rather than focusing on financing rates, would be what happens in Congress and with the White House. And though that's going to have be dependent upon what happens in November. Like you mentioned, James, we have two candidates with very different visions of how they would like to run the economy. I would think that if you propose higher taxes and so forth, that's probably not as good for the economy as tax cuts.
Future Economic Considerations
But, you know, there's a lot of things involved. We're going to have to see what happens in November. I think what this tells me is that the Fed is going to be out of the picture. More emphasis should be shifted to how the election turns out. That's right. Phil, thoughts? Yeah, I have one follow up question, Joseph, as far as impact on the real economy. Something we've seen in the last year is rising delinquencies and corporate bankruptcies. Do you think we'll see a sort of commensurate decrease in those as rates come down? Or I guess, how long does that impact typically take to be visible?
Analysis of Delinquencies and Corporate Health
So you're right that there has been higher delinquencies. But listen, when you look across segments, when you look at what the banks are saying and more of a historical view on, say, credit card delinquencies, you know, that part of it is just normalization. In 2021, 2022, were having very low delinquencies. Everyone's flush with cash. And now we're kind of going back towards how things were pre pandemic and some other things for bankruptcies as well. Note that if you look at market based measures like credit spreads, they're still pretty narrow. So I think when you look at the ecosystem as a whole, there are certain segments, let's say people who borrowed at floating rates.
Short-term Relief and Broader Business Challenges
So specifically medium and smaller businesses who borrow from banks who tend to be floating rate, they probably get some relief. Relief will probably be quick. But I think financing is not just one part of their problems. You have things like revenues and costs as well. I would not overplay this, the impact of financing costs for most businesses because that's just, unless you're super highly levered, that's just one part of the. Puzzle that makes a lot of sense. Yeah. Yeah.
Small Business Concerns on Financing
Before we open it up, I'll just leave on this note. This is from the note that we wrote earlier this month. It's available at head of macro.com. of course, always for free. It's, quote, small businesses aren't really complaining about high rates either. Just 4% of small businesses said that financing was their top business problem in June. Compare that to inflation, which is still the top business issue, with 21% of owners reporting it as the single most important problem in operating their business. And that's from the National Federation of Independent Business. And so there's a lot of focus on financing rates and all of that. But let's not forget that businesses have also borne the brunt of inflation.
Inflation and Economic Complexity
They too have suffered at the hands of the 2020 5% increase in overall prices since 2021. And it's not going to be as clear cut. They're telling you. Just 4% are saying that, hey, financing is a problem, which is to say that lower rates coming down doesn't necessarily affect most people who are concerned at this point in time. All right, we'll open it up to questions for the next 1520 minutes. Just feel free to hit the speaker request button and for some timely questions on Fed markets and macro while we do that. And Joseph, I want to, you know, thank you. You shared this chart that I sent out in this last note about household debt service payments.
Debt Servicing Trends and Economic Insights
And the fascinating thing was that if we think about the amount of money that households pay to service their debt as a percentage of their disposable income, that went up in the 94 hiking cycle. It went up in the 99 hiking cycle, it went up in the zero four hiking cycle, but it didn't go up in the most recent hiking cycle. We came into this cycle where household debt service payments as a percentage of income, disposable income were 9.8%. That's lower than the long term average of eleven. And that's unchanged with where were today versus at the beginning. And so again, not exactly evidence, whether it's businesses or consumers, that rates are overly restrictive.
Consumer Perspectives on Interest Rates
Yeah, I mean, for consumers, of course, the largest interest expense is your mortgage and everyone locked in very low mortgages. So that could be part of the reason why the higher rates were not as restrictive as people thought. We'll see if the, as rates come down, whether or not rates will be stimulative again. Absolutely. Absolutely. We're going to go to Zach first.
Hedging Activity and Market Sentiments
I'm adding you as a speaker. Zach, you're on. Hey, how's it going, guys? Thanks for sharing your thoughts on this space. I'm wondering if relative to the Fed futures probabilities, do you think the perhaps overweight pricing on more rate cuts than would be expected by the end of next year could reflect banks and other fixed income managers preparing for an easing cycle by building rate sensitive liabilities and hedging through Fed futures? I guess I'm wondering if there's any hedging activity or positioning that might show up in the Fed futures markets as more pricing for downside rates by the end of next year. Thank you.
Understanding Market Positions and Fed Futures
Yeah, that's a really good point, Zach. And it would be wholly consistent with what we've seen out of this market in the past. Right. This market is not folks saying we believe that pricing is going to be here. You've got hedgers, whether they're fixed income traders, whether they're banks, whether they're insurance companies, pension companies, trading these products, not necessarily because, like Joseph and I would use them to trade some macroeconomic thesis about where the Fed's going to be, but because they actually provide a hedge. And so it's hard for us to disentangle.
Probability Outlooks and Market Hedging
Ok, are people buying the January 25 Fed funds futures contract because they actually believe that rates are going to be lower than they are priced today? Or are they buying that as a hedge and they're largely price insensitive because some other part of the book needs to be covered? I mean, Joseph, that's consistent with what you found, I'm sure. Yeah, absolutely. So I think you make, Zack makes a really good point. It's not all a bet on what the Fed will do. There is a lot of hedging involved as well.
Economic Stability and Fed Behavior
Now, if, let's say we have disasters strike the US economy or the market or something like that, one reliable thing that you could expect is for the Fed to cut rates. And for example, in 2020, we have this big crash at Fed cut rates to zero. If you were long silver futures there, you would have made a killing. So let's say that you want to have some kind of downside insurance for something going really bad. Well, a lot of ways to do this. You can go short, you can buy puts and so forth. One way that people do it is sulfur futures and also social futures essentially cleared traded.
Investment Strategies and Market Liquidity
It's very liquid as well. So in that sense, it's an attractive option as a hedge. Yeah, that's a great question.
Discussion Introduction
All right, Zach. Makes sense. Yeah, absolutely. I appreciate it, guys. It seems like it's this forecast, perhaps, that might be expressed or might be interpreted from Fed futures. Could just be market flows from various managers. But I appreciate it, guys. Yeah, market flows and also a lot of folks getting stopped out of positions. We saw that earlier this month. A lot of those prices didn't even seem real where were pricing the serious chance of a intermediate rate cut at a time just because the stock market was 9% from all time highs.
Trading Dynamics
What I would say, Zach, though, on the bigger point here, is that when we think about trading this stuff, even though these things are the subject of price insensitive flows, folks who are buying or selling them, not because they have a macroeconomic view about what the Fed's going to do, and distort the price accordingly. But ultimately, these instruments settle into what the federal funds rate is during that contract month. And so, even though these things can deviate substantially from what you or I think their fair value is, that as long as we hold them to maturity with some semblance of risk management, that it doesn't matter. That flows distorted them very much prior to the trade. That with time, the contract will converge to whatever the real Fed funds rate is. I don't mean real inflation, just in terms. I mean what it actually is to what that Fed funds rate is.
Market Opportunities
And so, there have been opportunities, Phil and Joseph will remember this. When Silicon Valley bank blew up in the spring of last year, you had Fed funds futures pricing three rate cuts over a period where the Fed actually hiked rates by 50 basis points. So the market was saying, we're going to cut by 75. And what actually happened, ex post was the Fed hiked by 50. That was an incredible opportunity to fade the rate cuts. But you had to stay in that position. You had to have staying power. And that's where options really come into the equation. Makes sense. I appreciate the additional insight. It's weird to think about short term contracts being pulled to par, I guess, but, yeah. Thank you.
Global Macro Analysis
They are very interesting. They are. Yeah. Thanks, Zach, for the question. Okay, I'm going to add ape in paper. It's connecting. Let's see. Abe, can you hear us while we wait for ape? Joseph and Phil, I just wanted to point out that I think the interesting thing between macro trading products like rate futures and currencies, as opposed to single name stocks, is that you don't usually see the price insensitive hedging flow in single names. The way you do in rate futures and currencies. M and a deals that push dollar yen, one or two figures in a given day. Or a large fixed income manager trading fed funds futures. Not because they believe the Fed's going to cut, but because they have some other risks they need to hedge.
Currency Strength
Abe, can you hear us? Yeah, I can hear you very well. Yes, sorry, my network was repeated. Am I very rigid? Yes, we can hear you. Okay, so I want to ask on a global macro level. Because majority of the g ten currencies are in the rate cutting cycle. And US is about to enter a risk cutting cycle, how is all the other currencies going to play out? Because you see the currencies like the NZD and the AUD gaining strength and they're in a rate cutting cycle. Even the GBP, the euro, is in the rate cutting cycle and they are gaining strength against the us dollar. When USD in September starts cutting rates, which are expecting three rates cuts before the year runs out, how is the old market, global market, the old global macro of the GT currencies, how are they going to play out against each other since everyone is in the rate cutting cycle, excluding JPY?
The Dollar's Weakness
That's a good question. I think that, and I'll pass it to Joseph first, I think the question was about the rate cutting cycle affecting currencies, be it Aussie pound, euro, etcetera. Yeah, yeah, it looks like what that means is everyone is selling the dollar in a big way, maybe because the dollar rates are really high. And so now will they cut? They have a lot they could potentially cut. So be perfectly honest, I'm surprised by how weak the dollar has become. So one of the ways that I think about this is that whereas the US is cutting rates, the US economy outperforms other countries and so rates will stay relatively high, it will go back down to zero, whereas other economies, I think are, will not do as well as the US.
Global Stability Factors
And also, one thing that I'll note is usually when we have economic turmoil or political risk globally, the dollar tends to get a bid. Not really seeing that right now either. So maybe something's different or maybe it will revert. But right now, if you're totally right, everyone is just looking at the dollar cutting cycle and selling the dollar. Okay, thank you very much. Of course, that will be the quote of this x space Joseph ape. You're totally right. Quote unquote. Okay, we're going to put that on a t shirt. Okay, Phil, that'd be kind of fun, wouldn't it? We have one last question from Nemo, and then we'll do some closing thoughts.
Conclusion of the Conversation
Nemo, we're going to add you now as a speaker, you can unmute now and speak. Go ahead, Nima. Nemo, can you hear us? All right, well, that wasn't, that was enough monkey business for one space. We can't have two back to back apes. You know, there was already one with ape and then this monkey, and that's a little too much. All right, Phil, so closing thoughts? I think this is going to. But we're going to look back at the speech a year or two from now and say, look, this was the pivot point, very clearly unmistakable. From Powell, closing thoughts on today's wide ranging discussion? Yeah, no, I think the speech confirmed, of course, we're getting a rate cut in September, but it also did not really change the near term forecast for cuts.
Interest Rate Adjustments
I don't think, like, something that maybe we didn't get to in today's discussion was we already knew what was coming and how confirmed that. And, you know, which I guess he has to do for the market. But, yeah, we should see a pretty gradual pace of cuts, and that's what people expected even before today's speech. That's right. That's right. And I think when you think about fed cutting cycles, they kind of fall into two buckets, right? The one is how is the Fed responding to a substantial economic shock? Think 2008, think the pandemic in early 2020. They go big, they cut aggressively, they get real close, if not hit the zero lower bound. But then you also think about smaller calibrations.
Fed's Response Patterns
95, 98, 2019, were in all three of those examples. Funny enough, they cut by 75 basis points near consecutively over the course of just a few meetings. And so the latter, cutting cycles like we saw in 2019, called mid cycle adjustments. Those are almost designed to bring fed funds closer to what they view as neutral. I'm curious, Joseph, if we are definitively in one of those two buckets or where we might lean, is this closer to a cutting cycle where we get 200, 250 basis points of cuts, or is this something closer to a mid cycle adjustment? If we actually fully realized market pricing to the end of 2025, this would be unlike a cutting cycle we've seen over the past couple of decades.
Determining the Extent of Cuts
Either we usually typically cut from where we are, let's call it in, going into zero, eight, five and a quarter down to zero, or going into Covid, one and a half down to zero, or we do a 2019 or 1998 and cut by 75. So where are you leaning in terms of what the actual extent of this cutting cycle would be? So far, it looks like a mid cycle adjustment. When we look at economic growth continues to be above trend. When you look at unemployment rate, yes, it's rising, but it's still historically low. So, so far, it looks like that we are not in serious danger.
Future Economic Considerations
We could be headed there. But right now, so far, it's, it looks like it's a mid cycle adjustment. And I really think that going forward, when we look at the economy, it's going to be less about the Fed and much more about fiscal policy. You know, the Fed toggles interest rates we already saw over the past couple of years, you know, it's not that impactful on the economy. So going forward, I think how much money we spend, what we spend it on, what taxes are, and just the overall business climate shown by Congress and the occupant of the White House is going to be more important than the Fed. So I think right now what will happen is that people knowing that we have very different visions of the world depending on who wins in November, are probably going to wait and see.
Looking Ahead
So we could be in for a soft patch. And then what happens after November will determine what happens over the next couple of years. Absolutely. I want to thank both Joseph Wang and Phil Rosen for joining me in this conversation. Subscribe to Phil Rosen's daily newsletter, opening bell daily links in his bio. It's great. It's one of the first things that I read in the morning and follow Joseph Wang subscribe@Fedguy.com dot he has a great market wrap every single week, a video that distills whether it's the yen, the Fed, whatever it may be that's going on that week.
Final Thoughts
I use both of these resources. Thanks, guys, for joining this conversation. Thank you for being a part of this as well, reacting to this annual speech from Fed chair Powell. And, of course, put a plug in for what we're doing at Azoria partners. You can subscribe@headofmacro.com to our Azoria Substack, our newsletter, where I'm not tied to the whole weekly or daily thing that Phil or Joseph's doing, but responding and thinking at a high level about what's going on in markets. Most recent piece being markets is weird earlier this month about how the Fed really doesn't care about financial markets moving all that much unless it has a real impact on the economy.
Acknowledgments
This is James Fishback, Phil Rosen, and Joseph Wang, thank you for coming out, taking place in part of this conversation. We're big believers that open debate gets you closer to truth, whatever that may be at this point in time. But thanks for coming out this morning, and we'll talk to you soon. Thanks for organizing. Yeah, thank you. Thanks, Phil.
