บทถอดความฉบับเต็มของ Understanding a Shifting Fed, with Tony Crescenzi

⁓ transactions and stocks and bonds, and that's how they made their money. These days that's model has gone. But in 2009, ⁓ Bill Gross, the founder of Pimco, ⁓ called. I was in New York, he, of course, at Newport Beach, and ⁓ he had been looking at my work for some time. He had been ⁓ reading my work for since the 1990s, and I was trying to beg the elephant, so to speak, to quote Bud Fox from Wallst the movie Wall Street. Yeah. And ⁓ somehow it worked. I had an interview with him and the CEO, Mohammed El Arian, both in the same room. And Mohammed said to me, so what makes you different? I said, ⁓ from everybody else. I said, 'Cause I'm not like you. And this is me s talking to ⁓ PhD from Oxford. I said, ⁓ you know, understanding people, how markets behave is essential, you know, to you know, human human the human element. Yeah. So that worked. So I've been ⁓ a speaker-1: Yes. speaker-0: a market strategist slash portfolio manager since 2009, part of the investment committee, a group of about a dozen people that steers the firm's ⁓ investment decisions on maturity selection, these days mid middle part of the curve to cut to the chase, credit selection, currency exposure, things like that. We have a model portfolio and that's the basic thing that we do. Plus I I'm fortunate to speak to people like you to talk about the investment landscape. speaker-1: We've had Mohammed on before, he is he is impressive, but I think for people that don't have the history, what it must have been like to get that call from the Bond King. He was the Bond King at that point in time. speaker-0: It was a little shocking. ⁓ and ⁓ I I didn't actually d decide to to want to to work for Pimco. I j I thought I'd perhaps have him as a client. And so it was a kind of a shock in that sense. And ⁓ it was seven years after I had published my first of six books, ⁓ had ⁓ because of the back and forth discussions on email about markets in the nineteen nineties, I somehow I gained his respect and he endorsed the back cover. That alone, two thousand two, seven years before hiring. speaker-1: Like button follows. speaker-0: me was a shock and ⁓ an honor and still is ⁓ to this day. speaker-1: That's great. So what is your view and maybe the Pimco view on this new guy, Kevin Warsh at the Fed? speaker-0: I have complete confidence personally in Kevin Walsh and the Federal Reserve. We at PIMCO have complete confidence that the Federal Reserve as an institution is retaining its integrity and credibility, which is hard w hard earned. Yeah. Took forty years to to create credibility on the inflation outlook and to cut to the chase in terms of what markets think, looking at w ⁓ tips, so called tips, Treasury inflation protected securities, ⁓ suffice it to say they're priced for this U.S. consumer price index to average a gain on an annual basis of 2.35 percent. That's close to the Fed's two percent target. That tells you that there's a sense that Kevin Walsh and his and the FOMC, the Federal Open Market Committee, will make decisions that keep the inflation rate down. now I'll give you an impression from someone who worked with him. I've met him met him once in the the White House years ago and in the Bush administration, also at various events. But what do I know? ⁓ Janet Yellen, of an advisor to Pimco, part of what we call the Global Advisory Board, headed by Gordon Brown, the former Prime Minister of England and Chancellor of the Exchequer, the longest serving one in a 200 years, in fact, roughly. Anyway, she worked for with Kevin Walsh in 2009. Her term as governor, there's only seven governors, which including the Fed chair, they overlapped for a year or so. And she said about him in our recent discussions that And this is almost the exact words that he puts sound money above everything else. Sound money, which is to say protect the purchasing power of your dollar. Yeah. Which is to say to keep the inflation rate down. She also noted that during discussions in 2009, remember this is in the aftermath of the global financial crisis, that he was putting a lot of emphasis on the two percent inflation rate rather than the nine percent unemployment rate. Remember, today it's four point one. That's how she a lot. Then she reminds us that he in 2010 left the Fed because he objected to the Fed's bond buying, the quantitative easing as it's called. ⁓ And so that alone, so she has a lot of favorable things to say about him because you want a hawk there. In fact, there's an expression, an old expression, that only hawks go to central bank heaven. And it seems from everything he said that he is a hawk. The Wamarcus when he started, ⁓ were worried that he'd be too hawkish, which is to say but potentially raise the policy rate. Then in his last presser press conference after an FOMC meeting, he said, well, he's too dovish. He's letting inflation out of the bottle. ⁓ why isn't he joining the three other FOMC members who dissented in favor of a rate hike? Why isn't he leaning toward a rate hike? Maybe he's losing credibility. But everything he said, one thing in his press conference, for example, he said someone said ⁓ Do you do you have a soft target on inflation? Maybe it's not two percent. He said there is no soft target. There's only a target, and it's two percent. And he he said numerous other things that are very tough. Yeah. And ⁓ he's he's we would expect that he'll eventually pivot. Final word is for now is is ⁓ just ⁓ on his ability to pivot is probably pretty high. Fed chairs can make mistakes in their early days. ⁓ for example, Ben Bernanke ⁓ also Formerly an advisor to Pimco, part of that global advisory board I mentioned. He in 2006 when he joined the Fed ⁓ in January of February two thousand six, a couple of months later he made a comment to a CNBC reporter, Maria Botaromo. It's widely documented, you can find this on the internet, that was he thought was off the record, he said, ⁓ but it wound up being published ⁓ on air and ⁓ It

got him in trouble with the markets, which fell because he was indicating to her that perhaps there would be rate hikes, whereas before the the the off the the record comments, ⁓ there was a seem to seeming to indicate there won't be hikes. And anyway, there was a lot of volatility. What I'm trying to get is the you can have rookie mistakes communication wise. And Ben Bernanke knows the importance of communication. He's famously said that monetary policy is two percent action, ninety-eight percent communication. Words matter. Final word on that is Mario Draghi, I sat with him, former ECB, European Central Bank president. Sat with him in New York. I was shocked. I'm an Italian. We were talking about Italy earlier, off before we got on air. And ⁓ he was sitting in my office in New York and reminded of the importance of communication because in 2012, Europe was going through a lot of problems with a debt crisis. And he said, Do whatever it takes, believe me, it'll be enough. His words change everything. So words can be important. speaker-1: Whatever it takes. speaker-0: Walsh will be better with words eventually. He's extremely bright. We should he's a lawyer by trade. They're good with words usually. speaker-1: Yeah, they they usually are. So l let's let's ⁓ a couple things there. So I I love that. Hawks go to heaven, maybe doves cry. Is that we can say we could we could say that. ⁓ he he's definitely seen as as being a a hawk, ⁓ at least prior to this. You know, but the media, separate from the bond market, kind of paints him a little bit as this, you know, Trump puppet who's going to ⁓ you know, slash rates and and and be more political. That doesn't really seem to be hi his DNA, is that fair? speaker-0: Sure, he's his own man, so to speak. And ⁓ it may be that he's just playing the long game. ⁓ his term is f for four years, and typically a Fed chair will get renominated. So perhaps he's in it for eight years. How long is the President Trump in office? Two plus years more. Playing the long game, you could say already, he's been in office for a number of months already, Walsh, and ⁓ he's made it through without any comments. You haven't heard ⁓ equip Hey, ⁓ from Mr Trump, ⁓ the President Trump. ⁓ Worry Walsh. What is what is wrong with him? Or anything like that? ⁓ that'll be a future. This is So he's ⁓ playing the long game, and I think ⁓ s i that that's okay. I mean, it's not as if he's got to kiss the ring ⁓ at all, because the Fed is an independent body. And the thing that we should impress upon investors is that the Federal Reserve ⁓ chair is one vote out of twelve, and it it is it it's the the committee's already indicated it doesn't like. What's happened on the inflation front with the Fed missing its target for five years. And we should expect the the Fed, the FOMC, to make the right decisions to to protect ⁓ households and businesses and bondholders against the ravages of inflation in the end. And so one person vote won't matter as so long as the institution remains sound. Final view on that is it's four hundred PhDs ⁓ in economics and finance at the Fed. They're all working together. speaker-1: Academic, very, very kind of egg headed, and there then there's this J D here. speaker-0: That's right. And so perhaps ⁓ there's a conflict there that the J D, like Chair Powell, ⁓ former Chair Powell. Correct. Also a J D. I I I know that having talked to even Greenspan back in the day, Alan Greenspan, who unfortunately recently passed it over at a hundred years old, ⁓ turned a hundred March sixth of this year, he they would talk about the amount of PhDs there because they're proud of the fact they've got great in-house work. w work that AI perhaps is doing these days to to determine potential outcomes and the and all all kinds of work that for example, ⁓ can a PhD ⁓ give us a better idea about how AI and productivity will affect the inflation story than can a ⁓ than a J D? ⁓ arguably yes. I'm not this doesn't ⁓ I don't mean at all to say that The the chairwash ⁓ is any in any way beneath any of that. Doesn't have to be extraordinarily ⁓ experienced and and capable. And some people, even without a PhD or J D can ha can draw conclusions that probably be just as good as those that have those great degrees. But anyway, the the it's very tough question. Pro will productivity of Americans rise as a result of artificial intelligence? Will we be more productive? ⁓ the PhD will do the work. And I often think of the movie ⁓ The Martian. ⁓ you might recall ⁓ Mark Watney. He's on the planet, he's in trouble. He says, you know, do you do you do you wallow in that or do you ⁓ you just get to work and do the math? And so i it it seems like people are are going to be more people are gonna be doing be more productive. It seems like the PhD can see that they'll be more productive, and that can influence inflation. Real real quick thing, Greg, ⁓ on inflation. The typical way economists look at inflation outlooks is to take the wage figure and subtract productivity. And that's your inflation forecast. Because that that that formula tells you or the equation, something about the cost of doing business and therefore the prices that companies should set. So if wages are running as they are now, low 3% zone year over year. Productivity, people about 2% more productive. The so-called unit labor costs of of workers is really low, below the Fed's target. And this is a recent development because the wage figures were in the fours for a little while. It's come down because job growth isn't as strong. Productivity's gone up. So it seems like the wage-driven inflation, and that's 70% of the story, isn't there. So you don't need a PhD for that. It it seems logical, but the PhD can provide ⁓ more cover for the argument. And perhaps in a group setting, the PhDs get together and say speaker-1: More credibility, you can you can get the other academics like, Hey, I I'm an egghead too and ⁓ we we can speaker-0: Real quick

view on one other thing to say just hit me. 'Cause I know Ben Bernanke as an example. The the the reason why this is tricky and why the PhD versus the J D ⁓ argument ⁓ really stands is because no one really knows. ⁓ I I know Ben Bernanke and even at PIMCO in ⁓ meetings we've had with Nobel laureates, they are reluctant to make forecasts on productivity, even with all their formulas and research, because you just don't Really? No. Because there's three sources of how productive we are. It's our education, the stuff that we invest in. So if you have more equipment, you're probably going to be more productive. But the biggest and most difficult to to estimate is what they call TFP, total factor productivity. How productive are we with our skills and the stuff? ⁓ we just don't know the h what the use of AI will be. Let's just like we didn't know how the the internet ⁓ how we'd use it. speaker-1: Internet, right, yeah. speaker-0: The application. You could say it's the application phase. No one really knows. So Bram Bernanke, before he left us ⁓ to retire, he he said, talking about productivity, that it was up five one point nine percent ⁓ on average the last five years. So it's he said it looks like it's picking up. So the the the man on the street, woman on the street would say, looks like five years of data is not enough for the PhD. ⁓ so it so I'm gonna try to get at is you just don't re it's really difficult to know. So the PhD will think they have an advantage, but no one really knows. That's why it's a tricky argument in the boardroom at the Fed to to make that productivity will keep inflation down, so don't worry, therefore don't raise the policy rate. speaker-1: And I love the ⁓ Andy Weir, ⁓ author of of Martian Reference. We'll ⁓ we'll get to this a little bit later when we talk about Treasury, ⁓ Treasury buybacks, maybe the Hail Mary project, his his ⁓ more more recent, ⁓ more recent book. So let's talk a little bit about the the the changing or shifting policies of the Fed. There seems to be like two areas where Chairman Warsh is is willing to be different than Jerome Powell. And really that that's it sounds like the balance sheet and then Just communication, especially forward communication. So maybe we'll we'll start with the balance sheet. What is he what is he trying to do and what are the potential implications of that? speaker-0: Well, ⁓ one thing ⁓ we heard Janet Yellen say about Kevin Walsh and it's become obvious is that ⁓ he preferred the Fed to be on page nineteen of the Wall Street Journal and not page page w page one. ⁓ he wants the Fed to have less of an impact on the the markets, which he thinks should be influenced more by data, ⁓ because we've seen distortions in markets. speaker-1: They they really own the short end of of they they are the game and at least on that part of that. Yeah. speaker-0: $7 trillion so-called balance sheet. It's 20% of U.S. GDP, which is, by the way, Bembernenke has suggested to us in the past that that's probably going to be the run rate. But ⁓ the 20 percent figure. It used to be a lot lower. Yeah. But it to shrink the balance sheet, it means doing a lot of different things potentially. Now three trillion of the six and a half trillion or so is banks holding money at the Fed because they're They're worried about things. They're worried about liquidity, various needs they have, funding needs. They don't want to be caught short on money. So called reserves. So you'd have to tell a bank, hey, bank, XYZ, ⁓ why you hold so much money with us? You don't need to. Because the Fed in turn has to buy buy securities with that those those money. Don't h you don't need to have reserves. Take your three trillion back. ⁓ i if you need money, come to us. Come to ⁓ window. speaker-1: So's the reserves. speaker-0: ⁓ discount window, as it's called. It's a many decades old facility created a hundred years ago ⁓ in fact. the problem with that is a stigma. If if it's Wall Street, if the world depositors learn, as you know, that ⁓ the bank went to the Fed for money, they'll say, Hmm, it's maybe it's got some problem. I'm gonna yeah, or think of ⁓ one of my favorite movies, It's a Wonderful Life with Jimmy Stewart. Yeah. See a line out the door, people take the money. speaker-1: I'm gonna short the bank. speaker-0: Building and loans. So so there's a problem with that. So that that requires change in regulation or change in the way this hundred year old facility ⁓ is is designed. Or secondly, ⁓ c create a r ⁓ change the regulations, and this requires multiple agencies to get involved, regulatory agencies, that tell banks, hey, you don't need to hold as much money for liquidity. speaker-1: And this is kinda w I mean, this is they also need, yeah, all these other a agencies to kinda to get to get involved to to to do that, right? It takes a long time. speaker-0: And take a long time. It's possible, but it wouldn't maybe that's a trillion and a half of the six and a half trillion or so. Then it's almost three trillion of Better start adding my numbers together. It's gonna add up to too much. But it's it's a lot of there's a lot of cash in our pockets. It's multiple it's close to three trillion, I think. And ⁓ it's actually a seven trillion dollar balance sheet roughly. But we all like to hold cash for various reasons. That you won't be able the the Fed won't be able to change that. That part of the balance sheet story. The last part of it is a large chunk of the balance sheet is the ⁓ the money held by the Treasury Department ⁓ for maturing securities for daily spending. It has massive needs. It holds a trillion dollars at the Fed, so-called TGA, Treasury and Government Account. Yeah. Forgive me, I've forgotten the full name, if that's not it. It's it's G Treasury's general account, something like that. Anyway, it's money held at the Fed trillion dollars. ⁓ the The Treasury Secretary said, Well, maybe we'll reduce that. We have five days worth of money there.

Believe it or not, think of all of our daily budgets. speaker-1: That looks that's not like walking around money, right? speaker-0: Days of spending is is money, is a trillion dollars. Treasury needs so they might reduce that to th three and that only frees up a hundred or so billion dollars. So the balance sheet probably can't be shrunk by working with the Treasury to sh to reduce the the ma the rainy day money it has. So it's a tricky things. A lot of things involved in doing it. ⁓ so it might be challenging to get it to sh to shrink much. And is it even worth it? if markets enjoy the fact that the Fed owns securities? Fin final, final thing, Greg, is that two trillion dollars of holdings so I've we've talked about one side of the balance sheet. Then the other side where the money is. It's in treasuries and mortgages. Two trillion of that roughly is in ⁓ U.S. mortgage-backed securities. So by many estimates, and the and the way this and it was more. ⁓ the way those two trillion shrinks down to one trillion and lower is by all of us paying off our mortgages. You know, the balances go down, they go down, they go down. speaker-1: Yeah. speaker-0: But it will take till 2050 until they go to zero. So the only way to to get that down more rapidly is to sell securities. Imagine, therefore, ⁓ if the treasure if the Fed said, hey, ⁓ we have two trillion of mortgages, we don't like this. We want to have none. If they sold two trillion of bonds into the marketplace, it would cause havoc. ⁓ we're not expecting that, of course. We're expecting any sales whatsoever from the Fed in mortgage-backed securities because it would be disruptive. it would cause mortgage rates to rise and the last thing the Fed wants and of course the well Washington wants is for Americans' mortgage rates to go even higher than they are now. speaker-1: Trump has is was in real estate, has has a lot of New York real estate friends. They they probably don't don't want that. So it seems like that there there's some things they can do on the edges, but not a whole lot they can do to really bring it down quickly, at least. speaker-0: Yeah. And then given that the US has lots of debt, ⁓ it's probably okay to have the Fed hold since it has a remember printing press and so if if if there's a debt problem I could buy some of the debt. speaker-1: Had the fat you probably need to Also important is is that last time they actually tried to to do this in a meaningful way, it had impacts on the repo market. speaker-0: Yeah. re what was the word? Repo getin' or something. speaker-1: always something like, you know, Armageddon, it's always like, you know or pock Saspocalypse or ⁓ speaker-0: Saturnite. Re ⁓ that's you got it got it right. Repocalypse. Repo speaker-1: Apocalypse. ⁓ speaker-0: Whereas the overnight borrowing rate on Wall Street shot up to ten percent when the policy rate was less than half that, because it was difficult in the repo market to take Treasury securities, lend them in exchange for money. there was a scarcity of money. And ⁓ that caused those rates to go up, short term money market rates to go up, which can affect many, many, many things. In fact, ⁓ for example, commercial paper, it's a big market, a couple of trillion dollars where ⁓ sh Companies borrow for the short term. They have needs, you know, a factor factory XYZ needs parts and materials and they need short term monies before they sell the car, let's say, and and then pay it back. So that could affect those rates, for example. speaker-1: And a lot of hedge funds play in that space too. They are they are very levered and can do bad things when they're forced to force to unwind. And so th maybe that gets to the other kind of ⁓ area where there might be some some change, and that's really on on communication policies and and and you know, you you kind of said it is he he wants the the the Fed to be on the the back page and and ⁓ to to ⁓ not be the game its itself. ⁓ that's different because as you pointed out, really starting probably with Bernacke, but but and and following with Jerome Paul's just more transparency. We have dot plots, we have all this information out there. What does that look like? speaker-0: It's ⁓ that so it looks like it's changing. He as you said, he's already indicated he doesn't want to talk give much f so called forward guidance. He wants to reduce the Fed's ⁓ gatherings from eight a year to he's calling them fad family gatherings, family fights. speaker-1: Family fights. We'll get to the family fights later. Yeah, yeah, yeah. speaker-0: I was thinking about that this morning, and it's not a terrible idea because when it's every six weeks or so, there isn't a lot of data. There may be one employment report, which is a big jobs report, is very important, one consumer price index. So there's some ⁓ credence, some ⁓ I think there's some ⁓ positives in potentially having it every two months. So what's the big deal about that? It's not necessarily ⁓ a way to to to clam up, to to to to talk less. It's just simply a way for the data to be more indicative of where the direction of interest rates would likely be. And it's always been the case. Even before there was this forward guidance and communications and mentioned Bernanke, there would be a jobs report and the markets would react sharply, knowing the likely implication. And so if there's more data in between meetings, markets can fine-tune their own feelings ⁓ appropriately, and it probably will work. ⁓ There are other aspects though. Sometimes the markets want more clarity. I mentioned the Bernanke rule, two percent, ninety-eight percent. And ⁓ it the transparency can be helpful in terms of shaping ⁓ views. ⁓ there's probably a fine ⁓ a ba balance to be struck, and ⁓ I would have complete confidence that Kevin Walsh will strike the right balance in terms of reducing the amount of communication and providing enough that that markets will stay ⁓ stay stable. And f quick word on that

is it doesn't look like there's been change. ⁓ even though he's he's quieter than Chan Janet Yellen and and and Chair Bernanke and ⁓ going out of order. ⁓ and Powell. ⁓ yes, I went out of order in terms of the succession. But they so he's quieter than them. But the break even, the tips pricing for inflation s hasn't really moved and bond prices haven't moved. a lot, there's a little bit of movement lately, but there are a lot of other factors which we might talk about affecting it's not just about the wash and things he says doesn't say. So many other things affecting interest rates these days. speaker-1: It seems like that all new Fed chairs get tested a little bit and it kind of have to find their own personality at the podium. And you know, Jerome Paul wasn't great at first. Like he was criticized as as not being good, and then he kind of found his way. And that I'd just be curious on in your thoughts on Greenspan, if if Warsh goes back to more of the Greenspan era. Greenspan said a lot and and I just didn't understand what he was saying. And I maybe I'm not smart enough, but like he he used a lot of fancy words and you're like, I I don't know if that's dovish or speaker-0: He said he used to say things like, I don't know the exact quote, but ⁓ if if you understood me then he wasn't being obtuse enough. He wanted it to be confusing a little bit. speaker-1: I know Warsh will probably not use those words ⁓ in in a way, but y he didn't get a whole lot from I remember that there used to be the the Greenspan ⁓ briefcase if they have the how big it was, or if there's papers sticking out and and and ⁓ briefcase indicator. Yeah, because nobody really knew what he was. speaker-0: It's just ⁓ you know, it's just the markets having fun with a nerdy type thing. But speaker-1: May maybe there'll be the the the I don't know. The Walsh waistcoat or something. It's alliteration. We're trying to just try the war the Wory Warsh. I like that, so I'm trying to try to speaker-0: Probably with I've watching Wash, ⁓ I think about, you see, I still wear ties. I don't know. I just enjoy ties. and thinking about if he's making color choices, like I try to sometimes. I don't know what why I chose his color today, but I typically think about my color choices throughout the week. the only thing that makes me feel good about that is I know ⁓ David Beckham, you know, the famous soccer player and model, etc. ⁓ he has talked about how he plans out his week. I do that too with my ties because I want to To to feel a certain way. Like let's say for example a a client's account is underperforming, the last thing I want to do is be flashy and tone it down. Or if markets aren't in in good shape, tone it down. ⁓ other times you want to sound up seem uppy. So I'm wondering if his col his tie colors are gonna be a signal about anything. speaker-1: Right, right. You mentioned the the the family fight and that he's he's comfortable having family fights. ⁓ let's speak about that a l a little bit. Like d one, is it awkward to have this family fight when you have Lisa Cook and Jerome Powell still there? What what does that do? speaker-0: Within the the Eccles building, which is where the Fed works in Washington, which has been s ⁓ subject ⁓ to a lot of sort ⁓ and it was one of the things that got hot water. ⁓ this the it's a very ⁓ we talked about the integrity of the institution. it's one of the best collections of of serv civil servants in Washington. speaker-1: Supposedly it's gonna be real nice. Got drunk. speaker-0: And I I just see a group of ⁓ like NASA scientists really dedicated to their work. This is embedded, entrenched in the culture. I mean, 400 PhDs, you can imagine. ⁓ the mindset that they have, the seriousness of purpose that they have with the work that they did in their careers ⁓ to to obtain a s the PhD and reach the the the Federal Reserve's rooms. So I I I would doubt there's been any change in the way discussions are going, that the the presence of Powell, Jay Powell and Lisa Cook, probably seen as in in a very positive way and that their input is still highly valued. ⁓ so speaker-1: That's just noise on the outside. In internally, it's it's it it is the the scientists at at the factory, you just just working. speaker-0: I I do see it that way. The dynamic highly likely is has stayed in place because they have a process, it's it's evolving. And ⁓ so ch ⁓ Chair Walsh has five task force, one on we talked about the balance sheet, communications as well, those two. Also data sources is an ⁓ another one. I'll talk about that in two seconds. ⁓ inflation, which was probably the big question ⁓ for everyone, and then productivity. So these task forces one on data, for example, you can imagine within the board. the the ⁓ the boardroom at the Fed, they're thinking about how do we collect data and ⁓ so we could ha can we collect data any better than we do now? speaker-1: Such a lag now, right? I mean, that that is kind of a criticism of the Fed as they're kind of behind the eight ball and and so it's we we had talked about this this earlier. You were kind enough to talk to our our fixed income team as we were kind of thinking about all these all these things a couple weeks ago. And I think you you had said one of the other changes that no one's talking about. Like I asked you the question about communication policy and the Fed balance sheet. I think you said maybe coming out of this task force that just how we collect data and some of the survey information may be changed and people aren't talking about that. I thought that was a really wonderful insight. speaker-0: And extremely i vital and important. I think of the retail sales figure that's released monthly on on the consumer spending. It's horribly done, ⁓ my opinion. Sorry, Commerce Department. meaning that there it's subject to large revisions, which has got to mean it's there's some inaccuracies there in d in data collection and there's probably better sources.

speaker-1: I some of the revisions are crazy. speaker-0: Yeah. And so ⁓ f I, for example, and many ⁓ at PIMCO will ⁓ col look at data from the Bank of America. ⁓ so Pimco w works closely with Merrill Lynch, for example, and we receive those data and they're closely tied connect of course they're ⁓ connected organizations. ⁓ and then and the credit card data from the Bank of America is my bank to fair disclosure It's got to be pretty extensive and accurate. If if it says ⁓ people spending X amount more at McDonald's, I was there last month for ice cream. ⁓ then I got you. That's all I got. speaker-1: You got no way, you got a quarter pounder fries and I mean speaker-0: ⁓ I just I just wanted an ice cream. And I it's only a dollar, so I I went and got it. Anyway, they use the credit card and they know how many ice creams were bought with ac complete accuracy. But that's not something the Fed gets to look at ⁓ in terms of the the raw data. They know we know that they are collecting a lot of data aside from the the official data that you see reported in the news every day. So but I think they're trying to formalize it. speaker-1: Funny you say that it's because yeah, I was ⁓ driving in one morning and you know, all the economic data was was coming out around 8 30. And I'm usually in a little before then, but I I wasn't hit traffic, so I'm sitting in the parking garage listening to to all of them come out. And there was only this this last one, only one person got it right. And I think it was like the Bank of America because of that data. And I might be getting that that wrong, but it was somebody who had real time data. And everybody else was just completely off. speaker-0: Yeah, ⁓ although the official data could still be far different than the government's wrong. speaker-1: And then their actual data. That's right, because the government could be wrong. That's that's fair, that's fair as well. I think that was a great a great point. ⁓ you know, the other thing I wanted to ask you a little bit is is that you you you saw at least at this last meeting that they they had, more dissents. And I I wanted to ask you, is is it ever possible, because this would be unusual, ⁓ that the Fed chairman would be in the minority in terms of votes? speaker-0: Point, Greg, because ⁓ you're thinking therefore of ⁓ the Bank of England, where the Bank of England governor, the equivalent of the Fed Chair, can at times vote in the minority. Yep and and ⁓ so there'll be a policy change to hike or lower the policy rate in England, and you'll find the governor potentially in the minority. So w when we're wondering about Walsh, there's gonna be lots of ways to play off the W with his last name. Walsh is winning. We're worried about Walsh. ⁓ when we're wondering about Walsh, will he decide I needn't ⁓ like Greenspan, build a consensus around me? I can't do it, Fed's changed, or do as ⁓ Bernanke, ⁓ Yellen and Powell did and kind of shape their views around the consensus and and

then you see a vote on the F O ⁓ C ⁓ policy day, that's kinda like a ten to two or twelve to zero or nine to three. Is it possible then we should when we're wondering about Walsh that we'll see a a seven to five with Walsh in the five? ⁓ that's one of the questions I mean it is possible, of so we to say yes. ⁓ likely, no. ⁓ and the third element is w how would markets re respond to that? Would they get upset? I I think in England, you see interest rates are a little higher, inflation is a little higher. Perhaps it's to to the detriment to to vote in the minority. And so ⁓ we'll have to see how that plays out. So if I had a one of the bigger questions I would have about the what's coming up is is that. But I I I I think it'll evolve toward the nine three, seven ten two type of voting, twelve zero. I don't think it'll go toward this that in that way. Unless the data seem to be really difficult to assess, which ⁓ usually it's not, but we'll see. speaker-1: It would be interesting to your point. It's sort of then what it do markets care or not. I don't know. It'd just be sort of a break of of tradition. We talked a lot about the Fed. I want to talk a little bit about the Fed and Treasury relationship and and ask you about the long bond. It's this is where Treasuries were getting exciting. And then also the the recent maybe the talking about Hail Mary Project, the Treasury, the Treasury, ⁓ Treasury buyback. So so couple questions in there. and I'll let you start kind of wherever you think is is appropriate. speaker-0: So it's ⁓ confusing the government is attempting to bring down long term interest rates or to stabilize long term interest rates to help keep ⁓ long term borrowing costs down, in particular for h homeowners. Yep, prospective homeowners, and keep those mortgage rates down because they're influenced more by longer term interest rates. speaker-1: Let me let me ask you this. What was the your first mortgage rate? speaker-0: Good question. Now I'm really ⁓ this'll date me. Eleven point two five percent. Yeah. Nineteen eighty nine. Eleven point two five. speaker-1: So so mine was is is probably the the you know, late nineties and it was I think like ten percent. So th these are high. They they've been a lot higher than speaker-0: Great points, Greg. And I I would say ⁓ so there's a lot of noise. So what you have to do as investors, think past it. What are your guiding lights? the first thing is to decide where do I think as an investor that 10-year no 30-year bonds should be. And and typically it's simple math. I know the Fed chairs that we've talked to had the same equation. We have the same equation at Pimco. Three components. Try to go through them fast. One of them is the inflation compensation. As a bond investor, you want compensation for the potential inflation rate. Would I ex want to invest in the U.S. tenure at four and three-quarters percent if the inflation rate's ten? Probably not, because it's eroding the value of my money. I'd want a ten percent inflation compensation. The bond market is priced for two point three five percent over ten years. We agree that's a Fairly good assessment. The Fed targets two. So in our systems, we use two point three. So we're going to add these three together. Second component is the real neutral rate. It's the difference between the that inflation target of two and the rate that would put the Fed in neutral. So in combined, that brings it to that's a one point. So one point over the two percent inflation. It's so the real neutral rate is one. So you add the two and a half 2.3 to the one. Now ⁓ first of all, I I should digress and say, ⁓ how do we know that the three percent policy rate, one percent real, because it's remember it's three percent minus the one percent minus the the I'm sorry, it's the three percent minus the ⁓ inflation target. How do we know the three percent is ⁓ neutral? What maybe it's four or it's five, and the real neutral rate is much higher. Well, we we can sense from looking at the the housing market, that the three and a half-ish inflation ⁓ policy rate of today is probably restrictive. And also the job market has been slowing ever so much ⁓ the last couple of years. Seems like the policy rate is restrictive. The economy is slowing down ever so much ⁓ the last couple of years as well, seeing like a two percent rate. It was it was higher. So the policy rate is probably restrictive. Therefore, the the one percent real or three percent nominal, ⁓ is probably neutral. So I'm trying to that was really confusing, but ⁓ but suffice it to say he's probably what I should say. One percent, ⁓ real neutral rate, two and a half percent roughly or less for the inflation compensation. But the tricky one, and to your question Greg, early about the Treasury buying back bonds and all this uncertainty about the Fed speaker-1: Hey, I told you there'd be no math. speaker-0: All of the uncertainties ⁓ wind up in the long end of the yield curve from ten years and beyond, especially. It's a catch all for for things people worry about. So a bond investor will say, hmm, I don't know about this wash fed. Maybe inflation will be ten. I don't know about this treasury. They got big deficits, they don't seem to be doing anything about it. So I want I want more yield for taking for buying Uncle Sam's ten year treasury. It's thirty year bonds. Give me more yield. The typical number of the last twenty years is like I don't know, one little over one percent. We're using about one percent in our systems. It was negative for a little while, because in the twenty tens, people were so worried about things. They said, I don't need any extra yield for buying a ten-year note or a thirty-year bond. I'm just worried about getting my money back in this shaky world in the post global financial crisis. Right. So it was negative. And they didn't ask for any extra yield. But now they are. They're saying, I don't know about the Fed, I don't know about the

Treasury. Government. Everything is worrying me. speaker-1: The Fed really has, and we're talking about the Treasury, but like the the Fed really doesn't have a lot of control over the long end, right? Like they they they really control the short end. They can kind of control the kind of the middle, or at least influence the middle. That that that worrying and there's there's worrying out there, there's nothing they can. speaker-0: But with the wrong actions by the Fed that go against what the markets think, then the the the term premium would would be bigger. So you could say, so we got two point three for the inflation, one percent, real neutral is three point three, add another point for the term premium. A little more, maybe. Let's say it's a little more. And then so all it adds up to around four and a half for the fair value of the US tenure. Yeah. Let's say it's really the term premium should be one and a half, or something else in that equation should be higher. Let's say it's brings brings us to a fair value calculation of four and three quarters, where the tenure is today. Is that a reason to not buy bonds? We would suggest very strongly no. You should still, even if it's rich, meaning fair value is five percent, but it's all it's trading at four and three quarters, therefore I shouldn't buy it. Well, the income part of it's how potent. In since nineteen seventy eight, when yields are in in the current level or in this zone, according to the Bloomberg aggregate, between four and six percent, when it's been in that zone for for the last forty f almost fifty years, an investor is always had has had a positive return ninety six percent of the time one year later. Ninety six percent. Two years and three years later, one hundred percent of the time because the income side is potent. So speaker-1: But then it really drives the that fixed income. Your starting your starting yield is is an ⁓ speaker-0: Yes. Really important. So ⁓ so what I'm trying to get at, Craig, is in talking about the ⁓ this buybacks and all this uncertainty. You gotta stay focused on the fair value calculation and what the market's price for. Final word is really fast. Something called the forward rate curve. What's the bond market price for? You could either buy a 20 year treasury today or buy a 10 year treasury now and then 10 year treasury in 10 years from now. So the there's something called a 10 year tenure. What is a 10 year price for in 10 years? The math basically should work out so that the the numbers are equal. So the twenty-year Treasury yield today should be equal to the the 10 year, 10 year. Buying the 10-year today in another 10 year in 10 years. So these ten these forward rates are priced for much higher levels because of this steep yield curve, suffice it say. And it for five years from now the market's price for the 10 year to be at ⁓ roughly five and a half percent. Five and a half percent. So if the ten year is below five and a half percent, As a b buyer of duration, ⁓ as a person as an investor wagering on whether interest rates will rise or fall, if the yield's below five and eight percent, anytime in the next five years, you want. And things happen over a five year period that make interest rates decline. And so that's a pretty good wager. And it's why PIMCO's overweight duration has longer maturities than aver than normal, ⁓ because of that pricing. speaker-1: increase his his buybacks. I mean it's pretty small, like two to two to two to four or something in in that range. ⁓ but but why? I mean like it yeah I knew he bought some he bought some off the run and they they it it just like it had very little impact on the markets. Like what what was he trying to do? Was it a signaling mechanism? speaker-0: Well, maybe the it's most likely a stabilizer because we know with the vastness of the US debt having two hundred billion monthly deficit, that an extra two billion in operations, twice a month. So maybe an extra four billion, five hundred five billion per month in in purchases, it's not going to change things all that much. 'Cause as everybody has been saying in the media that it's really up to the the ⁓ a a change in fiscal policy and the def these deficits to To alter the equation. It may be the president's in his ear about interest rates, the too high, the too high. You hear this the president has said it many times. And the midterm elections coming. But ⁓ so I I would say that ⁓ it's it's ⁓ not call it not gimmicky, but it's just ⁓ it's gonna be tough to really change. speaker-1: doing that. So you're buying that back and you're you're you're so long term, 30 year, and you're you're using basically like six month rates. And so you're almost I heard somebody say this, I might have been on CNBC one one morning when I was in the gym, that you're you're ⁓ refinancing your mortgage with your credit cards. speaker-0: I was about to say something just like it, Rick. And ⁓ it's it's true. Th the that means the the the frequency at which the government must roll over its debt will ha will increase. speaker-1: Then puts pressure at at the Fed. speaker-0: And it creates uncertainty about financing? What if the US suddenly had a big deficit bigger deficit problem? speaker-1: Mm-hmm. speaker-0: You know, for some reason we needed to spend a lot of money and where are we gonna get it from? It's ⁓ we have to constantly ⁓ go to the markets for it. There is a lot of money in the short term realm. I wrote a twelve hundred page book on the money market, a doorstopper. It's mostly just to hold ⁓ god. ⁓ it's it's it do well for a while. ⁓ exact in in its lifetime, two a quarter of a million. Wow. ⁓ and but that was true. 'Cause I rewrote it. I mean ⁓ speaker-1: That was just flying off the shelf. your mom. speaker-0: Quite enough. anyway, so it's it's it's it can create uncertainty about the ability to refinance debt because of the whole credit card energy you just gave. speaker-1: Is that I mean is that

that then lead to like this this kind of I've heard this term with ⁓ it pushes more coordination between the Fed and Treasury and this whole ⁓ concept of of fiscal domination. speaker-0: Yeah, that's the idea ⁓ we used to talk about this in 2008, is it's one balance sheet, the Fed and the Treasury, in essence. ⁓ if it's not coordinated, ⁓ it'll have at least have to be reactive. The Fed's actions might have to be reactive because if the Treasury lowers long term interest rates, it's stimulative, let's say, to housing. And the Fed would have to weigh that in as one factor of amongst many, many in terms of d deciding on policy. Now importantly Treasury Secretary and the Fed Chair have weekly breakfast meetings. It's an annual it's a it's a tr it's a tradition. And so it's it's likely that ⁓ I wouldn't say there's coordination, but that there's at least an understanding. speaker-1: There's communication, direct direct. Yeah. speaker-0: And that'll help keep the single balance sheet ⁓ managed appropriately. speaker-1: Did want to ask a little bit more on the corporate side. ⁓ PIMCO has, I mean, first off, and and everybody who's listening and watching knows this, there's just this massive debt issuance out there to finance the build-out of the AI ecosystem, data centers and and and everything else that that is required. I know Pimco is participating in some of that. ⁓ and pass on others. So I I'd love your view kind of on on that or how you how you look at it. And if there could potentially be some crowding out where you have both governments that are very indebted and then you have all of this money coming back to the market. So so two questions. speaker-0: ⁓ So the first way to think about it is and it's a way to get beyond Walsh and Bessent, ⁓ to think about the other influences on interest rates. Talked about the fair value calculation, that's a big part of it. But the the big th thesis that I have, and we PIMCO emphasizes in its secular outlook in May, and there's a write-up on the Internet, that the global saving glut. I'll explain this from that's been in existence for twenty years is going away. There are huge spending, and you mentioned one, AI, huge spending is occurring in areas that look like imperatives that won't go away for years. So tech spending looks like it's highly competitive, there w will there will be lots of spending. Second one is national defense. What nation these days isn't d deciding to spend more on national defense for obvious reasons? Third. Energy security, similar idea. It started in twenty twenty two. ⁓ Europe needing gas from Russia and it's and now the the rest of the world with the Hormuz. So energy security would be an imperative. Fourth is supply chains, geopolitics, tr tr tariffs. So after COVID, companies want to be sure they have ⁓ inventory. And the fifth thing ⁓ to add to the list is vr companies just borrowing more money. U.S. bank loans are up seven percent on a roughly annual pace the last year and a half tends to coincide with normal GDP. So there's a lot of demand for money. But it wants money. Spending is ⁓ going everywhere. So that's money that from 2006 onward, 2006 is the ref I give that year because that's Ben Bernanke, the Fed chair, had this thesis of a global saving gun that we weren't spending in these areas. So the money wound up in treasuries. So China bought lots of treasuries. In twenty twenty two it had one point one trillion of them. Today there's six hundred thirty three billion of them. Half trillion gone. So it's a lot of spending occurring worldwide. And that's pushing up interest rates. It's it's already in the price, this idea, ⁓ but it is a c crowding out in a sense, but it's not a bad thing because it nominal GDP, ⁓ meaning all spending when you include the inflation, it's running in the sixes. Good for p revenues, profits, stock prices, credit spreads. speaker-1: Yes, it's very strong. speaker-0: So it's not a negative thing, ⁓ is a way to think about it. It's just an F factor in keeping the interest rates a little playing. speaker-1: So what do you do with these these AI bonds? How do you approach them? speaker-0: We know and anyone can sense that the amount of borrowing in that realm will be high for some time. We're seeing lots of o ⁓ indicators on that. So you've got to be really careful about what you're investing in. Should an investor invest in the chips and the technology and the application themselves or the data centers where we've put more focus lately, where there are lease payments. And then perhaps ⁓ in a bespoke arrangement ⁓ ⁓ agreement, whatever the word is, you the the payments for the the lease payments could be structured in a way that keep the bondholders safe. In other words, ⁓ an investor could decide, could could be faced with, well, there's a five year ⁓ loan of bond on a data center, and in five years they'll pay us back, that's on the maturity date. You could either just take that as a given or say, hmm That sounds a little risky. There's gonna be a lot of that borrowing that in five years it's a wall, a debt wall. And when the world perhaps the the world won't be as interested at that time. ⁓ and instead structure the the the bond deal, so to speak, can't find the right words, that compliance would like. It's a deal arrangement. speaker-1: Is this the compliance approved words? speaker-0: structure the issuance ⁓ s such that the lease payments will go toward ⁓ some ⁓ the the the repayment of the debt in some way. It could be locked up or could be just put aside. So you've got to be really careful and selective and ⁓ ensure that the structure of the debt issuance is is ⁓ will protect the bond investor. So that's what we want to do and and also look ensure that ⁓ the cr the credit we face, so to speak. the the entity that ultimately has to pay us back is a major entity that has substantial cash flow. And that's there's many of those big companies now. So this isn't the pets dot com era.

Yeah. We're not investing in pets dot com. We're investing in major names like Meta that have cash flow generation that ⁓ is sh we believe will be sufficient to speaker-1: So you're getting you're gett you're getting a high yield, which is great, ⁓ but then you have to make sure you you're comfortable with the structure and then also the the the borrower. Yes. Maybe the the guarantor of of it. Because I know that sometimes there's these SPVs and rental. speaker-0: And and also just ⁓ ensure that there's ⁓ adequate compensation for the amount of issuance that's occurring and there's different ways to think about that, and ⁓ ensure that the yield is attractive enough because th th we know these entities are interested in in borrowing money and ⁓ this is as as a result they might be willing to pay ⁓ the investor more. speaker-1: Yeah. All right. Let's finish with a quick lightning round. Favorite Fed chair? speaker-0: Well, we mentioned both of us mentioned ⁓ Greenspan. I used to have ⁓ and the whole briefcase indicator you mentioned, ⁓ to me, something I'd forgotten about 'cause on my wall I had this these cutouts of of Greenspan of him carrying ⁓ the suitcase. Yeah. And so I I ⁓ he was my first first love of Fed chairs was ⁓ Alan Greenspan. Just my first team, New York Mets, when they play the Cincinnati Reds and I adored Pete Rose and as tough as he was against and fighting Buddy Harrelson of the New York Mets. ⁓ I Ben Bernanke's the the one Fed chair that I've talked most with, though. And so I've had a a great ⁓ affinity for for him and respect for him simply because I've had more conversations with him and ⁓ and I th I believe he did a fabulous job and is in the right place at the right time after the global financial crisis and kept us ⁓ all afloat. speaker-1: All right, so we'll call it a tie. Well your your your your boyhood love ver versus more they're all they're all they're all great. All right. So if you were Fed chair for the day, what would you do? speaker-0: They're all great though. Give a speech. speaker-1: So long speech, short speech. speaker-0: A speech that ⁓ that appropriately moves markets, just to feel the power 'cause it's it's the power of words. speaker-1: Hungry for power in that one day. All right. All right. So when you're not reading the Fed minutes or a bond prospectus, what are you reading? speaker-0: I I really enjoy ⁓ and this partly reflects my age with this is not so I've two one magazine that just came to mind Reader's Digest large print edition. But the equivalent in the in the in the academic world is to me foreign affairs. The print is larger. I don't know why. But it's written by ⁓ the numerous articles in there written by ⁓ Acad Academia and people in policy the on major issues. So I really love ⁓ the Foreign Affairs magazine and no ads and that's that's one of the top ones I like a lot. All right, all right, all right. And Mad magazine. Why? I don't know. It just goes back to the seven speaker-1: Magazine. All right. ⁓ Alfred Newman. All right. Hobbies. Any hobbies? speaker-0: I like ⁓ stargazing. ⁓ you know, I grew up in the seventies and I remember the Apollo missions, believe it or not, and so flabbergasted by this the pictures ⁓ having gone around the moon ⁓ recently. And ⁓ looking forward to just watching, you know, read NASA go on NASA's website a lot and keep on top of all the the space stuff and ⁓ thrilled about the this the recent company news. ⁓ guess, you know wanna talk about companies about space sex. Everybody s knows about space X. I'm thrilled about the idea of s of space that ⁓ people are embracing increasingly lately. speaker-1: Would you ever go to space if you had the speaker-0: I've thought about that ⁓ crazy idea 'cause I no one really knows what the bidding process is for going on these some of some of these and that they accept low bids and h high bids and I I'm afraid to go on a Merry Go round 'cause I did motion sickness. But I I thought of that 'cause my dream young was to be an astronaut. So I you never know. speaker-1: Sony. Well this was out of this world. So thank you so much for speaker-0: So much credit to you and FEG, it's amazing. speaker-1: If you are interested in more information on FEG, check out our website at www.feg.com. And don't forget to subscribe to our communications so you don't miss the next episode. Please keep in mind that this information is intended to be general education that needs to be framed within the unique risk and return objectives of each client. Therefore, nobody should consider these to be FEG recommendations. This podcast was prepared by FEG. Neither the information nor any opinion expressed in this podcast constitutes an offer or an invitation to make an offer to buy or sell any securities. The views and opinions expressed by guest speakers are solely their own and do not necessarily represent the views or opinions of their firm or of FEG.