NCI: Fed Cuts 50bps: Bull Run or Bear Plunge?

Ram: [00:00:00] All right. I'm pleased to be joined by Bob Elliott on the next episode of Lumida Non Consensus Investing. And the title of this is called Fed Cuts 50 Bips, Bull Run or Bear Plunge. Bob and I spoke actually a few days ago at the Future Proof Conference and, was a lively discussion. We said, gee, this is like the appetizer for a better podcast.

I can't imagine better timing around this as well. But there's so many topics we want to get into. First off, Bob is a co founder, CEO and CIO of Unlimited. He's built hedge fund strategies for more than two decades, including while he was at Bridgewater, on the investment committee at Bridgewater.

He's got an ETF. As well, I believe the ticker is HFND, and he's authored hundreds of Bridgewater's widely read daily observations. So some of the topics we're getting into are the 50 dips rate cut, where are we in the cycle? What are the coincident leading indicators telling us how to [00:01:00] position?

What did everyone go wrong and where are we going from here? Bob, so how are you? 

Bob: Good, good. Thanks so much for having me. The tan of future proof, the, for me, it's more just like a, lingering redness from sitting out in the sun for, a few days, I don't know about you, but, but, now we're back, I'm back to my undisclosed location, no longer at the beach.

Are you in a basement? Are you in 

Ram: a bunker? 

Bob: I'm in a, I'm in a faceless office building in, the suburbs of New York. And haven't had, haven't taken the time to decorate it. You've got a beautiful backdrop. I look like I'm in a bunker, but Hey, who, who's, who's comparing any 

Ram: background, for next time there.

So we'll put you on an island somewhere. 

Bob: Yeah, exactly. Exactly. On the boardwalk at Huntington beach, in the sun. But yeah, this is great. Thanks so much for having me. And, I had, yeah, it was such a fun conversation. It was a lot of fun. 

Ram: So 50 bips. Now I'll frame it up for you. And the question is really going to be, [00:02:00] What was the thought process of the Fed?

And did they make the right call? So that's the, so the preface for everyone. Look, this is the most widely anticipated set of rate hikes that we've seen. No question about it. Pavel had previewed that for quite some time, including recently at Jackson Hole. Now in the week leading up to, these, rate cuts, excuse me, you went from, 25 bips to 50 bips, despite strong economic data and, markets, rallied and then gave back the gains on the day of the FOMC meeting.

And then, yesterday markets went to liftoff mode and then now they're having a breather. So tell us about these, the 50 dips and cuts and, Did the Fed get it right? Are they trying to seek a soft landing? Was it necessary? Should there have been 25 dips? 

Bob: Yeah, I love the opening question of the presser, where Steve Leeson's Hey, when I look at the data that's been released since, the last time you talked, it certainly wouldn't align with an aggressive, cutting cycle.

And I [00:03:00] think that, hit to the nubby heart of the issue, which is that if you just took, you just take the macroeconomic environment at face value and you look at traditional indicators like where inflation is, which is still moderately elevated relative to the Fed's target, you look at where growth is, which is, it continues to be it's not lights out, but it's certainly not consistent with a recessionary environment or close to it.

All time highs, 

Ram: stock prices, record employment. You 

Bob: look, you look at, asset prices, stocks are at highs, you look at spreads that are at tights. None of this sort of in aggregate would align with a, a meaningful, shift to easing, right? Most of it would align with, something that looks closer akin to maybe a gradual easing, maybe flat, but not an aggressive easing.

Now, what the Fed has decided to do is they've made a choice. They've, they believe, I genuinely believe that they believe that inflation has beat and that they should become accommodative. Now, that isn't [00:04:00] the normal way in which central banks respond to the set of circumstance, but it's also not an unheard of way to respond to the circumstance.

And look, if that's their reaction function, then so be it. You as a trader have to just respond to what their reaction function is and pencil out what's likely to happen as a result. 

Ram: Now, I think the best argument for cutting rates is coming from this idea that real interest rates are elevated.

I'm going to share my screen here. And the theory is that if real interest rates are elevated, then policy is restrictive. So here you've got on the screen the real 10 year U. S. Treasury bond yield versus the 10 year U. Yield, the real bond yield is in, blue, you can see the easing we had here when the 10 year was at, record lows, around 1.

5 percent level, and, so this is the argument. So is this a legitimate basis here? This is, it even puts it even more sharply, actually, this is the real federal funds rates. So looking at the shorter end of the curve, you can see here [00:05:00] that it's around 2. 8, 2. 9%. Historically, this has preceded. Get your open source epitome of the past and the future.

You can find this podcast and much, much more on our YouTube channel. We hope you find it useful and we look forward to 

Bob: hearing from you. The idea of real rates being a useful indication of the tightness of money is, it's certainly, a consideration, and certainly, if you had 10 percent interest rates and inflation was 10 percent versus 10 percent interest rates when inflation was 2, those are two very different things.

I think the problem with it is it's it's too gross of a measure in terms of trying to assess the tightness of monetary conditions relative to the economy in any way that's [00:06:00] useful. And I think the challenge is if you try and understand, how do you understand how tight monetary policy is relative to conditions?

The way you do that is by looking at how conditions are transpiring in this current interest rate environment. If you just look back over the last, last two years, we basically have interest rates at the same level. Real GDP has been running around 2 3 percent that entire time. Most employment measures are, have been at or above, what the underlying labor force growth is, particularly prime age workforce, labor force participation or prime age working as a share of the prime age population at all time highs, you don't see the sorts of things that would indicate That current interest rates are very tight, or, some people say it's very 

Ram: there.

What do you make of the quality and composition of employment? Meaning, we're seeing a greater shift from full time to part time, multiple jobs, and, some contraction in average hours worked. Is [00:07:00] there something to read into that, or is that a head fake? 

Bob: Yeah. Multiple jobs is a pro cyclical measure, not an anti cyclical measure.

It is a good job market when people can get more than one job because there's more than one job available for those who are working hard. So it's pro cyclical. So throw that one out. Number two, in terms of the composition, I think there's a lot of focus on, for instance, jobs going to the native workforce versus foreign born.

I would emphasize that the Fed. should have no preference between a worker who was born in the US and a worker that was born abroad. It has no, should have absolutely no impact on macroeconomic policy. And I don't believe it does have any impact on macroeconomic. It might be a matter of politics, but we're not talking politics here and the Fed isn't playing politics with that workforce.

So that's a big part of it. Now, if you go to part time versus full time, you have seen some increase in part time work relative to full time work. First of all, recognize it's come from the household survey. The [00:08:00] household survey is it's not a great survey in terms of it's, it's errors, the breadth of it's errors, and on this point in particular, a lot of that part time has been based on preference, not based on economic circumstance, and we've only seen about 0.

3 percent rise in prime age, Part time work for economic reasons, which is, 0. 3 percent of the labor force is just not that big a deal. And yeah, it's true, but it's also, it just doesn't matter. And relative to the big picture, anyone who's in the prime age labor force who wants a job, like people are working, they're working at all time highs in terms of a share of the prime age workforce.

Ram: Right on. And what are your thoughts on, say leading and coincident indicators? I'm going to share this tab as well. So this is showing the red lines, leading economic indicators, that's been, cratering. And later on, I'll show you the components of the leading economic indicators, which I know you can quote.

The blue line here, you see the coincident economic [00:09:00] indicators. The coincident economic indicators are at all time highs. They don't show signs of slowing down, they're measuring real economic variables like income, and sales and industrial production utilization, all the rest. But the leading economic indicators are negative.

So I just showed a chart of, hey look, real interest rates are high, isn't that restrictive? Now I'm, putting myself in the awkward position of defending the Fed because I think they actually got this wrong. And I'm showing that, these leading indicators are turning negative. So isn't that a reason for the Fed to cut 50 bps?

Bob: The leading indicators suck. And, and the reason why that is, is that they're based on things that are not, that are not that relevant to what actually drives economic conditions. And in particular, the underlying premise under the leading indicators really is two different pieces. One, that manufacturing conditions are meaningful and lead the rest of the economy.

And that's not true. And it's certainly increasingly less true. Today versus where it was 60 years ago or [00:10:00] something like that when, it became a meaningful composition when GE was a 

Ram: player in the economy at Honeywell. 

Bob: Exactly. It's just, it's just not that big a deal.

Number two, actually, I should say sentiment measures, which have been proven, to be quite poor through the cycle. So if you look at things like, ISM or things like that, it used to be a pretty good coincident indicator of economic conditions. And now. Over the last really 10 years, it's deteriorated rapidly.

Part of that can be explained through partisan related issues. And then number three is the various interest rate measures that it's looking at are very dependent on a credit sensitive economy, and a credit sensitive expansion. We do not have a credit expansion, credit driven expansion here.

Private sector borrowing, both the households and businesses, is at the top. To add a recession like lows, and so it's just not that helpful, to understand what's going on, with these credit measures, because it's just not a big driver. We have an income driven expansion, not a credit driven expansion, so on [00:11:00] all those accounts, it's just a bad indicator, and it's proven to be a bad indicator over the course of the last couple of years.

‍