Compiled and edited by TechFlow
Guest: Alfonso Peccatiello, Macro Expert, Founder of The Macro Compass
Moderators: Ryan Sean Adams, Co-founder, Bankless; David Hoffman, Co-founder, Bankless
Podcast source: Bankless
原标题:Fed Rate Cut: What Will Happen to Markets?
Air Date: September 18, 2024
Background Information
Jerome Powell and the Federal Reset are on the verge of cutting rates, but the question on everyone’s mind is…what happens next?
Alfonso Peccatiello, known as “Macro Alf,” is a macroeconomic analyst and investment strategist who joined the group to help us solve this problem.
Are these rate cuts timely or too little too late?
Will the Fed cut rates by 25 basis points or 50 basis points?
Will we have the recession or soft landing the Fed is hoping for?
What happens to crypto assets?
We discussed all this and more with Macro Alf, one of the leading thinkers in the macro field.
Fed policy lags
In this podcast, David and Alfonso discuss the Federal Reserve’s monetary policy and its impact on the economy.
· Alfonso pointed out that the Fed seems to be lagging behind in the current economic situation, especially in terms of interest rate cuts. He mentioned that the Fed’s main task is to maintain economic stability, although its official goal is to control inflation around 2% and maintain a healthy labor market.
Alfonso explained that the Federal Reserve’s focus on curbing inflation over the past two years has led to a rise in real interest rates to positive territory, which has had different effects on borrowers and investors. For investors, high real interest rates make it more attractive to keep money in cash, reducing the incentive to invest at risk. For borrowers, the burden is increased because they have to repay their debts at higher interest rates, which slows down economic activity.
The risk of over-tightening
David raised the question of whether the Fed was too slow in keeping interest rates high, potentially leading to a slowdown in the economy.
Alfonso believes that the current situation is that the Federal Reserve may lag again in cutting interest rates. He warned that if the Fed continues to do nothing, there is a risk of a sharp slowdown in the economy.
· Alfonso further stressed that the monetary policy tightening in the past 18 months has exceeded the levels in 2006 and 2007, which means that the current policy is very restrictive. He mentioned that historically, the impact of monetary policy is usually delayed and may take 12 to 15 months to show its effect. Therefore, although many people now believe that the economy can withstand high interest rates, in fact, the lagged effects of the policy may show negative effects in the coming months.
Future economic outlook
The podcast ended with a discussion of the future economic direction. Alfonso mentioned that although the market is generally optimistic at present, historical experience shows that when the economic situation seems stable, it is often a precursor to problems. He reminded the audience that although the current policies seem to be effective, the long-term lag effect cannot be ignored, and there may be greater economic challenges in the future.
Why hasn’t the economy collapsed yet?
In the podcast, Ryan asks a key question: Why hasn’t the economy collapsed despite the Fed’s tightest monetary policy in history? Alfonso explains why.
Alfonso pointed out that the current economic lag effect is very long due to a variety of factors. Normally, when interest rates rise, borrowers (such as households and businesses) will borrow less, thereby reducing spending. However, the current situation is different. Since more than 90% of US mortgages are 30-year fixed-rate, many households will not feel the impact of rising interest rates immediately. Their fixed-rate loans mean that even if the interest rate on new mortgages reaches 7%, existing homeowners will not be directly affected because their loan interest rates are still low.
Enterprise response strategies
The situation is similar for companies. Many large companies (such as Apple and Microsoft) adopted a strategy of extending debt maturities before the pandemic, borrowing long-term debt at low interest rates. This means that even if the Federal Reserve raises interest rates, companies do not have to immediately bear higher borrowing costs. Therefore, companies still maintain ample cash flow in the short term and may not reduce investment or spending due to rising interest rates.
The impact of fiscal policy
In addition, Alfonso also mentioned that fiscal policy in 2023 also supported the economy. The Biden administration implemented a large-scale fiscal deficit, which brought additional capital inflows to households and businesses. This fiscal stimulus offset the tightening effect of monetary policy to a certain extent, so that the net wealth of companies and households increased despite rising interest rates.
The bad news
In the podcast, Ryan and Alfonso discussed the meaning of bad news in the current economic situation. Ryan mentioned that the Fed’s tools do not seem to work as expected, and the potential problems in the economy are like a tsunami coming in the distance. Although there is no obvious impact now, the crisis is approaching.
Alfonso pointed out that in the past few years, the market’s reaction to bad news is very different from now. In the pre-epidemic period, weak economic data was often seen as good news because it meant that there might be interest rate cuts and fiscal stimulus. However, Alfonso believes that the situation has changed now, and bad news has really become bad news.
Changes in the economic environment
Alfonso explained that in past economic environments, the market was accustomed to viewing bad news as “good news” because it usually meant that the Federal Reserve would take measures to support the economy. He mentioned that from 2013 to 2019, the market generally believed that bad news did not mean real risks because the Federal Reserve always supported the market behind the scenes.
However, the current situation is that the economy is close to the brink of recession, and the impact of bad news has become more obvious. Alfonso emphasized that when economic growth is weak, the tolerance for unemployment is reduced, and any economic data that is lower than expected may cause market panic. For example, the United States currently needs to create about 120,000 jobs per month to maintain a stable unemployment rate, but in fact, the private sector only creates about 100,000 jobs per month. This gap means that once there is bad news in the economy, the market will react quickly, causing the stock market to fall.
Memories of the past
Ryan asked when was the last time investors felt that “bad news was bad news.” Alfonso replied that this situation can be traced back to the 2008 financial crisis. At that time, bad economic data meant that a recession was approaching, and the market sentiment changed fundamentally.
Bond market signals
Alfonso also mentioned that the current bond market is also sending signals. Bad economic data will cause bond prices to rise and yields to fall, reflecting the market’s expectation of further easing by the Federal Reserve. However, the stock market often falls as a result, showing the market’s concerns about the future economic outlook. In this case, bad news is not just bad news, but exacerbates market anxiety.
Alfonso stressed that the impact of bad news has changed in the current economic situation, and the market can no longer easily ignore bad news. As economic growth slows, the market will be more sensitive to bad news, and investors need to re-examine this new economic environment.
Fed rate cut forecast
In the podcast, David and Alfonso discuss the possibility of an imminent rate cut by the Federal Reserve. David mentions the market’s expectations for a rate cut, especially the discussion about a 50 basis point cut.
Alfonso’s opinion
Alfonso believes that the Fed is likely to choose to cut interest rates by 50 basis points. Here are a few reasons he gave:
Missed opportunities: Alfonso pointed out that the Fed should have cut interest rates in July but failed to act in time. Now that the economic situation has worsened, they should not continue to be stubborn, but should make up for their previous mistakes.
Communication strategy: He believes that the Fed should clearly communicate the reasons for the rate cut, explain that it is to correct previous mistakes, and show that they realize that the economy is slowing and are prepared to take more easing measures.
· Future meetings: The next Fed meeting is in November. If they only cut rates by 25 basis points this time and the economy deteriorates further, they will have to wait until November to cut rates again, which is not wise risk management.
Market expectations: Currently, the bond market is already pricing in future rate cuts, with the market expecting a 250 basis point rate cut over the next year. If the Fed does not follow suit, stock markets may get nervous because they rely on bond market expectations.
Nature of rate cuts
David asked if the Fed chose to cut rates by 50 basis points, would that mean they were moving quickly.
Alfonso said such a rate cut could be seen as a correction for failing to cut rates in July, reflecting the Fed’s attention to the economic slowdown.
Impact of the global economy
Alfonso also mentioned that the global economic situation is also affecting the Fed’s decision-making, especially the impact of China’s economic slowdown on the U.S. He emphasized that the Fed needs to be cautious in cutting interest rates while conveying their understanding of the economic situation and their response measures.
Alfonso believes that the Fed should take a 50 basis point rate cut to respond to current economic challenges and reassure the market through clear communication. He stressed that the current rate cut is not only a response to the economic slowdown, but also an insurance measure against potential risks in the future.
Elizabeth Warren’s open letter
Ryan mentioned that Senator Elizabeth Warren recently wrote an open letter to the Federal Reserve calling for a 75 basis point rate cut. Ryan asked Alfonso what he thought of the letter and whether it would affect the Fed’s decision.
Alfonso’s analysis
Alfonso believes that Warren’s letter is actually a political bargaining tactic. Here are his thoughts on it:
Political bargaining: Alfonso believes that Warren’s request for a 75 basis point rate cut is actually an attempt to influence the Fed to make a final decision of 50 basis points. By making a higher request, she hopes to prompt the Fed to take more aggressive rate cuts.
Fed communication strategy: Alfonso noted that the Fed cannot communicate publicly during the dark period (i.e. the silent period before the policy meeting), but they still convey information through the media. He mentioned that in the past the Fed has communicated its intentions to the market through Nick Timiraos, a reporter from the Wall Street Journal.
· Market reaction: Alfonso mentioned that at the beginning of the dark period, the market’s expectation for a 50 basis point rate cut was only 10%, but with the Timiraos report, this expectation quickly rose to 55%. This shows that the Fed can still influence market sentiment through the media during the dark period.
Stability and instability: Alfonso cited economist Hyman Minsky’s view that “artificial stability actually leads to instability.” He believes that the Fed’s attempt to avoid recessions and market panics by controlling market volatility may itself lead to greater instability.
Alfonso stressed that as investors, we need to understand the rules of market operation and manage risks on this basis. He believes that the Fed is trying to convey their intention to cut interest rates by 50 basis points, and Warren’s letter is part of the political game and may not directly affect the Fed’s final decision.
Market reaction
In the podcast, David and Alfonso discuss the market’s reaction to a possible rate cut from the Federal Reserve, specifically the impact of Elizabeth Warren’s request for a 75 basis point rate cut on the market and the Fed’s decision-making.
Alfonso’s analysis
Market expectations: Alfonso pointed out that the market has already begun pricing in the possibility of a 50 basis point rate cut by the Federal Reserve in September, and this expectation has reached 60%. He further stated that the market also expects a 25 basis point rate cut in November, and a higher probability of another 50 basis point rate cut in December. This shows that the market generally believes that the Federal Reserve will further cut interest rates in the coming months.
Importance of economic response: Alfonso stressed that the effectiveness of rate cuts depends on the response of the economy. If the economy can quickly adapt to rate cuts, it may bring positive results. However, the positive effects of rate cuts usually take one to two years to appear, so the Fed’s policy needs to be forward-looking rather than just reactive.
Performance of risky assets: David raised the issue of market participants’ focus on risky assets, such as cryptocurrencies, especially in the context of the Fed’s rate cuts. Alfonso pointed out that rate cuts are generally positive for risky assets, especially when the economy is doing well and rate cuts are seen as support from the Fed. However, if the rate cuts are in response to economic weakness, the reaction of risky assets in this case may be different.
· Historical example: Alfonso mentioned the example of Japan in the 1990s, pointing out that after the economic bubble burst, although the Bank of Japan quickly cut interest rates, the market did not recover. This is because the rate cut was not a proactive measure to support the economy, but a passive response by the central bank in response to economic weakness.
· Alfonso believes that the impact of the Fed’s interest rate cut policy on the market depends on the nature of the rate cut. If the rate cut is seen as support for the economy, the market may react positively; but if the rate cut is seen as a remedy for economic weakness, the market reaction may be suppressed. Therefore, investors need to pay close attention to the Fed’s policy trends and the actual performance of the economy in order to make corresponding investment decisions.
How to prepare
Understanding the current market environment
Performance of risky assets: Alfonso noted that if the economy enters a recession, risky assets, including cryptocurrencies and stocks, could suffer. As cryptocurrencies are increasingly viewed as risky assets, they could be sold off to raise cash during a market downturn.
The impact of deleveraging: In times of economic downturn, investors often face pressure to deleverage, which can cause all asset classes to become more correlated and show similar price movements. When investors need cash, they will not think too much about which asset to sell, but will only choose assets that can be converted into cash quickly.
Portfolio Adjustment Strategies
Maintain diversification and risk balance: Alfonso mentioned the “risk parity” strategy, which recommends that investors pay attention to the contribution of various types of assets to the overall portfolio risk, rather than simply allocating funds in a fixed proportion. For example, ensure that each asset contributes the same risk in the portfolio.
Reference to historical data: Historically, investors tend to underestimate the extent of the Fed’s interest rate cuts. During recessions, the Fed usually takes more aggressive interest rate cuts, so bonds tend to perform well in such situations.
Recommended asset classes
Bonds: Bonds typically hold their yields during a recession, especially if the Federal Reserve cuts interest rates. Although bond prices have risen, they remain a relatively safe investment option during an economic slowdown.
Gold: Gold tends to perform well during times of economic uncertainty, and as central banks continue to add to their gold reserves, demand for the metal is likely to continue to rise.
Safe-haven currencies: During times of economic crisis, investors often turn to safe-haven currencies such as the Japanese yen and Swiss franc, which tend to remain stable during market turmoil.
Avoid big losses
Focus on risk management: Alfonso stressed that investors should prioritize how to reduce risk in their portfolios rather than looking for hedging tools. Avoiding large losses is the first principle of investing, as large losses can lead to financial situations that are difficult to recover from.
Reassess your portfolio: When considering a possible recession, investors should review their asset allocation to ensure that they are not overly concentrated in high-risk assets.
The possibility of a recession
When discussing the possibility of a recession, Alfonso offered his thoughts on a recession in the next 12 months. He believes that the probability of a recession is about 50%. Here are a few key factors in his analysis:
The impact of fiscal policy
Rapid fiscal stimulus: Alfonso noted that the current political environment allows governments to act quickly to stimulate the economy when the economy weakens, spending more money to stimulate the economy. This is different from past situations, such as during the 2008 financial crisis, when fiscal stimulus measures usually took 6 to 12 months to be introduced. Today, the government’s quick response can play a role in stabilizing the economy to a certain extent.
Private sector leverage
Lower leverage: Leverage levels in the private sector are relatively low, meaning that companies and households are less indebted. This means that if the economy faces a recession, it may not be as hard hit as in the past. In 2007, many households and companies had excessive debt levels, which led to the financial crisis.
Market expectations
Market Probability of Recession: The market’s current expectations for a recession are between 35% and 40%, lower than Alfonso’s 50% estimate. This suggests that market participants have relatively high confidence in the future economy, but there is also the possibility of underestimating risks.
Although Alfonso believes that the probability of a recession is about 50%, he believes that if it does happen, the magnitude and impact of the recession may not be as severe as in the past. This is mainly due to the government’s quick response to the economy and the low leverage level of the private sector. Investors should consider these factors when evaluating the future economic situation in order to better adjust their investment strategies and risk management.
Currency depreciation
In discussing currency debasement, Ryan and Alfonso mention changes in the money supply and the impact of such changes on the economy and asset prices.
Definition of currency devaluation
Currency depreciation: Currency depreciation generally refers to a decrease in the purchasing power of a currency, resulting in the same amount of money being able to purchase fewer goods and services in the future. Ryan mentioned that although the economy may be in a recession, currency depreciation is an almost inevitable phenomenon.
Changes in the money supply
Fiat currency system: Alfonso noted that monetary policy has fundamentally changed since the United States abandoned the gold standard in 1971. Now, the issuance of dollars is no longer tied to a hard asset like gold, which allows the government to create new dollars without limit.
The impact of inflation: As the value of the dollar continues to increase, the risk of currency devaluation increases. Alfonso explained that when the government creates too many disposable dollars through deficit spending, the supply of goods and services in the market cannot increase quickly enough, which eventually leads to rising prices, which is called inflation.
The role of government and banks
Deficit Spending by the Government: The government creates new disposable dollars through deficit spending. For example, the government may write checks to citizens, increasing the money supply in the market. This practice has been going on for the past 30 years and has led to a devaluation of the currency.
Credit creation by banks: Banks inject credit into the economy through loans, such as mortgages. Alfonso explains that banks create new money by assessing the borrower’s ability to lend based on their future cash flow potential. This credit expansion further drives up asset prices.
Impact on asset prices
Housing Market: Home prices continue to rise due to low interest rates and continued credit creation. Even without significant wage growth, increased borrowing capacity has allowed people to purchase higher-priced properties.
Comparison with Gold: Alfonso also mentioned that the actual growth in housing prices may not be obvious if measured against gold. This suggests that the increase in housing prices is mainly due to the effects of the fiat monetary system rather than the intrinsic value growth of the property itself.
Monetary liquidity
The concept of monetary liquidity
Importance of the denominator: Ryan mentioned that the key to understanding the flow of money in the economy is the “denominator”. He pointed out that the terms used by governments and central banks (such as quantitative easing, fiscal deficits, etc.) are actually describing the creation or destruction of money. In most cases, these measures are increasing the money supply.
The normalization of fiscal deficits
Transformation of fiscal deficits: Alfonso pointed out that fiscal deficits have changed from being a “defect” in the past to a “feature” now. He believes that the government’s $1 trillion in deficit spending has become the norm, and this change has had a profound impact on liquidity and the economy.
Impact on investors: This continued fiscal spending will support economic growth, but it may also bring inflation and market volatility. Investors need to pay attention to how these policies affect bank reserves, inflation, economic growth and market performance.
Metrics Investors Should Watch
Government spending and deficits: Investors should focus on large government projects and stimulus packages, especially tens of billions of dollars in spending, as well as the annual budget deficit. These data are public, and investors can get a sense of the government’s spending by looking at the monthly deficit data released by the U.S. Treasury.
Spending efficiency: In addition to focusing on the deficit itself, Alfonso stressed the importance of spending efficiency. How the government uses these funds and where the funds go will directly affect the productivity and long-term growth of the economy.
The widening gap in social wealth
Increased wealth disparity: Alfonso also mentioned that the implementation of fiscal policies is exacerbating wealth disparity. As younger generations (such as millennials and Generation Z) gradually become the main voters, they are facing increasing economic pressures and may promote different policies to seek wealth redistribution.
Sustainability issues: He believes that the current economic system is not sustainable and that there may be greater social and economic pressures in the future that will prompt policy changes.
Depreciation-resistant assets
Classification of Depreciation-Resistant Assets
Stock Market: Alfonso mentioned that stocks are an important asset that resists depreciation because companies are denominated in US dollars and can generate cash flow. He emphasized that although companies will grow in the long run, investors need to pay attention to the valuation at the time of purchase and avoid buying stocks at too high a price. He advised investors to choose high-quality companies and invest at reasonable valuations to ensure good returns in the next 10 to 20 years.
Risk asset allocation
Aggressive assets: In the portfolio, Alfonso recommends allocating some risky assets, such as cryptocurrencies and gold. Although these assets have no cash flow, they have different monetary characteristics and can provide diversification for the portfolio.
Defensive asset selection
Bonds: As defensive assets, bonds often protect portfolios during recessions or periods of deflation, but in some cases (like 2022), they can underperform.
Commodities: Alfonso also mentioned that commodities, as dollar-denominated assets, can protect portfolios during periods of inflation, and are therefore also defensive assets worth considering.
Macro Investment Strategy
Macro Hedge Fund: Alfonso shared his plans for his upcoming macro hedge fund. He believes that the current changes in the macro environment have brought huge investment opportunities, and that specific strategies can take advantage of these macroeconomic fluctuations and provide a diversified source of income for the portfolio.
Conclusion
Key takeaways:
1. Federal Reserve’s decision:Alfonso believes that the Federal Reserve may take a 50 basis point rate cut to respond to the current economic challenges. He reminded investors to pay attention to the market response under different economic environments, remain flexible, and not be stubborn in their own views.
2. Importance of asset allocation:In an uncertain market environment, the key to protecting your investment portfolio is to rationally allocate assets that resist depreciation (such as gold, stocks, cryptocurrencies, etc.). Investors should adjust their investment strategies in a timely manner based on their own risk tolerance and market changes.
3. Keep learning and adapting:The market is changing rapidly, and investors need to constantly learn and adapt to new economic situations. Alfonso’s educational platform “Macro Compass” provides a wealth of resources to help investors understand the macro economy more deeply.
Finally, thank you to all the friends who listened. Remember, investment is risky and decisions should be made with caution. The future is full of uncertainty, but we will continue to move forward on this road of exploration. I hope everyone can keep an open mind and actively respond to challenges on this journey. Thank you for your support, and see you next time!