How The Fed Really Works | Joseph Wang

Joseph Wang 0:00
If you’re interested in the markets, I would, there’s a lot of really good books, none of them. Definitely don’t read the textbooks, those things they learned in school, they’re not useful. I would prefer books written by market practitioners. So you have the market wizard series where you where you actually talk to real people and see, see what they’re like.

Eric Chemi 0:22
Hi, everybody, welcome to Wealthion. I’m Eric Chemi. Of course, the Federal Reserve right now the Federal Open Market Committee, the eff out FOMC, the Fed Jerome Powell, they are dominating the conversation right now, the big picture macro environment is all about what is the Fed going to do? What have they done? What are they doing right now. So I thought, we need to understand the mentality of the fed the mindset, what’s going on in their brains for the decision making, that they’re doing. So I thought we need to have on the Fed guy, Joseph Wang. So he’s here to explain all of these things. And you can find him on social media. He’s the Fed guy. He’s also the CIO at monetary macro. He’s also the author of central banking one on one, he worked at the Fed, he was a senior trader on the Federal Reserve’s open market desk. So they’re sitting at the center of the dollar system, its ultimate, and infinite provider of dollars. They’ve got access to all regulatory data, all financial data, and they’ve got open lines of communication with all the major market participants, the banks, the central banks, across the world, everybody, you name it. So Joseph is maybe one of the smartest people that I could talk to. So I’m a little bit intimidated. In another life. He was also a lawyer. He’s got a BA in economics from Northwestern University, a JD from Columbia Law School, and a master’s in financial economics from Oxford University. So, Joseph, I hope I described you correctly with all of your knowledge and education and degrees. I’ve never stepped foot, an Oxford University. So it’s impressive that you have the degrees..

Joseph Wang 1:53
You should have left out the lawyer part. LOL

Eric Chemi 1:55
I think the lawyer part is probably very important, because so much of what’s going on is related to the law, right? It’s related to how are they interacting in a government setting? It’s not just a banking setting. And maybe I’m wrong, you know, better was just

Joseph Wang 2:11
Yes, yes I think lawyers make great central bankers. And thanks so much for having me on. It’s a pleasure to have you back on to great channel, and really appreciate all the great work you’re doing and pleasure to meet you now, for the first time, Eric.

Eric Chemi 2:24
Yeah, it’s fun. So it’s like our audience will be familiar with you from the past. It’s nice to have you back on here. For those that are familiar. First question I have. Everyone thinks the Fed, they always say, Oh, the Fed doesn’t know what they’re doing. Right rates are either too high, or they’re gonna let inflation get out of control. No one’s ever happy with what the Fed does. But clearly the Fed, they’re reading whatever they’re reading, they’re thinking through whatever they’re thinking through, they’re meeting their people, they’re having their discussions, they think they’re making the right decision, according to them. So my question to you is, what is going on in their head? What do they think right now about what they’re doing? And how does..

Joseph Wang 2:56
A great question, and it’s something that’s always on the market’s mind, because the Fed has such a tremendous influence on financial assets? So I think that’s a hard question. Well, first of all, the Fed is many people, right? When the Fed gets together and makes a decision. It’s a group, it’s a big group of people, you have fed governors, you have fed presidents, and they all have a slightly different approach to the world. But I will say, though, that today, the Fed is more transparent than it has ever been. So you have fed people giving speeches, you have Jay Powell giving press conferences, you have quarterly, you have this dot plot where they tell you what they think the future will look like. So it’s a lot more transparent today than it was before. They’re so

Eric Chemi 3:38
transparent now compared to what it used to be. I mean, you go back to the Alan Greenspan days, even earlier, there were no press conferences, right. There was not as many speeches, you didn’t even say what the rate was, the markets had to guess what the rate was through the transaction. So do you think all of this transparency, all the talking that they do, has actually hurt monetary policy?

Joseph Wang 4:02
That’s a great point, like you mentioned, backed back out, you know, a few decades ago, the Fed was a very mysterious organization. As you mentioned, the Fed could hike rates, and people wouldn’t know whether or not they hiked rates, they had to go and look carefully into the money markets. There’s, there’s a good case to be made that right now, there’s too much transparency, because there’s so many different speakers, and they all have slightly different perspectives. And that could cause a lot of chaos. But I think overall, this transparency that we see today, is really helpful for setting monetary policy.

Eric Chemi 4:32
What would happen if they canceled all the press conferences is just hey, this is the number at least they just said, here’s the number, right? We’re at five, we’re at five and a half x. But we don’t say anything. What do you think? So I think

Joseph Wang 4:44
we went back to the secrecy that we had before. One I think is one thing first, I think is that the market will have a lot more difficulty pricing in the path of policy, and I think that will make the Feds job a little bit more difficult. So for example, Traditionally speaking, we think of monetary policy as acting with long and variable lags. And a good argument that recent fed Fed officials have been making is that because we’re more transparent, there’s less of a lag. And why is that the case, because when the Fed is really transparent than the market knows what the Fed is thinking, and then they could price that into market. So for example, a few months ago, the Fed was telling everyone, we’re going to be higher for longer, we’re gonna keep interest rates really high. And you can see that in the two year yield, which was comfortably above 5%. That’s because the Fed is very transparent, telling the market, how we think about things we’re going to do that gets priced into the market, which of course immediately impacts the real economy, if you want to go out and get a loan, those are the market rates you’re going to face. So if you have a transparent fed, the market reacts more quickly to what the Fed is thinking and the Fed is more efficient in pricing their policy, if we didn’t have this transparency, though, maybe the market will be not be pricing with the Fed is what the Fed wants it to maybe the market is thinking that the Fed is going to cut really soon, whereas the Fed in their own mind is thinking they’re going to hold higher for longer. And then what you will do is, what will you see is you will see rates being lower than what the Fed wants, and maybe inflation accelerating higher than what the Fed wants. So it would be a less effective way of pricing of conducting monetary policy. Now the second point, though, that I would like to make is that once one good thing about having a mysterious Fed is that there’s a lot more uncertainty in the market, the market, when the market feels more uncertainty, I think there’s less likely for people to go and lever up, because they don’t really know what the Fed would do. Maybe the Fed, maybe a market purchasing was thinking that the Fed will hike rates, but the Fed actually cuts because the market participant doesn’t properly understand what the Fed is thinking. When you have these degrees of uncertainty. You have people who take less risk, so there’s less leverage in the system. So I think maybe that could make the system in a sense a little bit safer, because you you discourage risk taking.

Eric Chemi 6:58
It’s interesting you say that, because it makes me think their own, there’s almost like a few points of rate policy baked into the mystery, right? Like, if I didn’t know what they’re going to do, I could probably have a lower actual rate, because people will just be like you said, less likely to gamble less likely to lever up or right now, you got to pound that rate super high if you want to get rid of that ability of people wanting to gamble. So if you do wonder if actually transparency, by its nature, transparency is is loosening, right, by definition, it’s dovish, at any rate, think the

Joseph Wang 7:34
Fed especially has his history, the words perceive that it’s a dovish fed, because in the past, it’s been very quick to cut rates has been very quick to ease monetary policy. When when when markets have gone down or when it thinks that there’s some kind of economic slowdown. So that definitely is going to condition the market to always think that the bias is towards easier monetary policy. And we saw that for for the past couple years. It wasn’t until very recently, until the Fed seems to have gotten finally beaten out of the market. You have a

Eric Chemi 8:06
tweet recently, you said on November 14, people can find at fed guy 12 justifying effect. As inflation declines, the Fed would cut nominal rates to maintain real rates. Otherwise, policy would be tightening, even as inflation declines and growth slow. So you know that we people are all excited after CPI, the Fed is truly done hiking now. But they can’t sit on the sidelines. So you point out they actually need to be cutting rates just to keep policy from tightening. Further, do you think they would actually do that? Do you think they would risk igniting a melt up or about

Joseph Wang 8:40
the way the Fed views the world is heavily influenced by what you would read in school, like the Fed recruits heavily from PhD economists and they have a certain way of thinking, the way they approach the world is that they look at it through the concept known as real rates, and that is nominal minus expected inflation. Now, John Williams, the president of the New York Fed, recently gave a talk and not too long ago about this, from my perspective, he seems to be trying to teach people about about this, because going forward, obviously inflation is trending lower, right. So if inflation is trending lower than unless nominal rates are also trending lower than what you what you will you get is you get real rates increasingly higher. Now, from a PhD economists perspective, you know, you don’t want to be increasing real rates, even as growth is slowing in even as inflation is going lower. What that will be doing, it will actually be tightening monetary policy, even as things are going in the right direction. Now, that doesn’t make any sense, right? At most, you would keep the stance of monetary policy, you will keep real rates at the same level as you’d gradually move the economy move inflation towards where you want it to be. So today, as you mentioned, we had a good inflation print inflation was a little bit lower than expected. And I think the expectation going forward is that we probably continue to trend lower, it’s going to be bumpy, it’s gonna be lumpy. But we’re going to try and lower. Now, in that context, it definitely makes sense for the Fed to not cut policy rates to boost the economy, but cut policy rates just to maintain their current stance of monetary policy. And so we see that being priced into the market today. If you look at the shorter end of the curve, let’s say the two year yield, that’s been rallying significantly. So it looks like it’s down about 20 basis points today. And you can see rate cuts being priced in as soon as some probability of next March,

Eric Chemi 10:36
you mentioned these PhDs that they have working at the feds, a very highly educated intellectual organization. But then we see sometimes in the real world, the real role doesn’t work. Like the equations work, they don’t work, like the theories work, there’s a lot of friction, there’s a lot of, you know, all the stuff that we see with behavioral economics, people don’t do what the mathematical theory says they’re going to do. Do you think the Fed sometimes gets caught up in too much theory too many PhDs this mentality, but it’s like, hey, no one’s behaving this way. Right? The reality of the stickiness and friction is causing a disconnect between theoretical policy to

Joseph Wang 11:12
appreciate it personally, I don’t believe that macroeconomics is an issue is a useful way of looking at the world. I mean, the way that I look at this is that they look at the world as if it’s a giant math equation. But the real world is not a giant math equation, because the relationships between variables are changing all the time. Like, if you’re doing physics, for example, let’s say that I have something, I drop it today, it’s going to fall to the ground at 9.8 meters per second squared, it’s the same, it’s the same acceleration and speed, whether I drop it here, or in London weather today, or 100 years ago. So when the relationships between variables are stable, you can definitely break out your big math equation. And you can, you know, you can do a lot of work there. But that’s not how the economy works. That’s how markets work. And so that approach, I think, has been not helpful and understanding the world. And we see, we see the results, right. So again, just a couple of years ago, you have the Fed staff all in one voice telling you that you know, inflation is transitory, it’s going to go away, was not that way at all. Or you can actually go back even further. So the Fed has these confidential briefings or cocktail books, they are what the Fed staff presents to the FOMC. When they make their decision, they get these classified after a lag, you can go back and look at the track record for the toolbox. They are really, really bad. So I don’t understand why anyone actually pays attention to this, which is actually part of the reason why I like Jay Powell is as Fed chair, Jay Powell, as we discussed earlier, it’s not a PhD economist knows that models are all for reference only. So I don’t think that he places too much weight on this. But one thing I want I want to go back to is you mentioned whether or not they would be concerned about a melt up if they were race. And that’s definitely what’s happening today. Right. But I would take a step, just a high level. And note that the Fed is concerned with that as a mandate, which is which is full employment and price stability. It’s not about growth, it’s not about asset prices, although those things feed into it. There’s also of course, a concern for financial stability as well. So you know, we have this huge melt up, I don’t actually think it impacts monetary policy right now, because, but we have inflation trending in the right direction. We have employment at multiday around multi decade lows. Now, it could you can make an argument that a reflation of asset prices could make people go and buy more stuff, and, you know, can make inflation rise again, that’s possible. But I would also remind everyone for the past 10 years, we’d have equities continuing trend higher and inflation was very subdued. Until after COVID.

Eric Chemi 13:49
There’s so much to unpack there. Okay, the let me begin with the transitory inflation comment that was just dead wrong, right? Just completely wrong. And you’ve got all this groupthink going on over there. All these smart guys that that think this is the answer. And they were just they were wrong. Right? Like you said it. We all know it, they know it now. And you’re talking about the toolbox. You talk about these forecasts and that the forecasts are wrong. Or the dot plots of like, here’s where we think rates are going to be those are typically dead wrong, too. So what what are they actually putting credence and I think that’s what I’m trying to get a sense for is, who do they rely on for information? Or what are they reading? Or what is their Bible? Right? What is the this is what we believe, and this is how we get there? Because it does often seem so far removed from the reality.

Joseph Wang 14:42
So that’s a good question. So how does the Fed go about gathering information? And so what information does it see and how does that impact how they see the world? Well remember, first of all, at the FOMC, you have a lot of people and they have slightly different ways of looking at the world. But at a high level. Of course you have the very, very A strong contingent of PhD economist is like a few 100. There, they get their data, their employer, a few countries, I know probably the largest. So, so what happen is that, you know, they have their reports, tons of reports, and you have to look on the FOMC. So you have a lot of PhD economists who are actually sitting on the FOMC and making decisions. So they view the world that way. So they have their models, you know, the well known fed model DSG, DSG. stuff. They that’s one that’s one perspective, you have other perspectives as well, you have people who have a very large human intelligence network. So if you listen to let’s say President Barkin, speak, he would, he would spend most of his time just out in his district, talking to people talking to businesses, listening to how they’re perceiving the world. And you have many, you have many people in other districts who would talk focus on banks will focus on, you know, energy, and so forth. So there’s a lot of human intelligence as well. And so they take all that together, and they try to make a decision as to what what to what to do. Now, historically, okay, so every Fed chair is different. Now, historically, when you hadn’t, say Yellen, or you had Bernanke, these are PhD economist, people. So they would hold they would think plus a lot of weight on how the PhD economists condition is thinking about the world. I think chair Powell is a little bit different. So but he’s been going through and, you know, I guess, he changes every now. And then I remember when he first became chair, he was looking at models, and he was taking like, these are for reference only. And it sounded like he would emphasize more on his own judgment, maybe emphasize more on on the human intelligence side. And it seems like when push comes to shove, he runs, runs to the model people and does what they think. And we saw that actually very obvious in 2020, when he was all listening to the model people and just easing rates and doing tremendous amounts of quantitative easing, buying mortgages, even when home prices were going up 20% year over year. Now, that’s absolutely crazy, right? Why would you be buying mortgages when when home prices are going up? 20% year over year, but you know, that’s? That’s a mystery. But I imagine it’s because all the model people were telling them, this is how you run policy. But could today though, today, I think that he feels more comfortable relying more on his judgment, less and less on the PhD economist pupil, that’s seems to be what he’s hinting at in his recent remarks. But we’ll see he seems to change every now and then. But it’s a complicated discussion, there’s a lot of different, there’s a lot of different How would you say, not interest us, but a lot of different factions within the federal have ways of viewing the world? And so it’s a it’s an interplay between them? It’s like

Eric Chemi 17:45
any company, right? There’s turf wars, like are these guys think this, these ones think that based on their background, or? Or any classic, you know, I think about a tech company, we got the sales guys, and we got the engineers, right? They have a very different way of thinking about what’s going to make make the most profits. But you mentioned quantitative easing, what have we learned really about how QE really works? And now you know, Qt, would you say it’s going well, so far, like we and then we can get into some of these balance sheet comes in, right? The balance sheet is shrunk by a trillion dollars without triggering the repo crisis, like we saw in 2019. But But QE and now to t, what do you think that they have learned? What have you,

Joseph Wang 18:21
they’ve learned that they don’t really know how this works, which is why they want to get the balance sheet as small as as small as as I can work. So just a little bit of history on QE. So here, we happened simply because we were at 0% interest rates, and the Fed wanted to give additional combination. So the Feds tools are interest rates. Now normally, that’s just adjusting the overnight interest rate and moving it up or down 25 basis points. But after the great financial crises, rates were at zero, so and the economy was still kind of stuck in a rut. So what were they what was the Fed to do rates are already at zero. So the idea they came up with was, you know, let’s try to lower longer dated yields, let’s say a 10 year yield? How do you go about doing that? Let’s just go and buy enormous amounts by by hundreds of billions by trillions. And of course, if you have a lot of people buying longer dated treasuries to the yield would go lower. So it was a way to stimulate the economy. Now, in retrospect, of course, okay, so that’s one angle. And you also have a lot of people who look at who focus on the quantitative aspect that the Fed is printing money and buying treasuries, we’re gonna have hyperinflation and so forth. So I think there’s two angles to this. One is how it impacts rates and the other is the quantity of money in the financial system. So at when the Fed first started doing this, there’s a tremendous amount of misunderstanding as to how this would work. And I remember back after 2008, you know, you had gold prices just go up every day, because there’s a lot of people who are looking at this and thinking we would have imminent hyperinflation, that did not happen. So A lot of people in the markets, not just the Fed didn’t really understand what what how this, what this was doing. And of course, the Fed thinking this would stimulate the economy. Well, we had 10 years of very slow growth and very low inflation. So things didn’t really unfold in the way that they expected. You have these papers from the Fed that show that, you know, we actually did something, doing quantitative easing lowers interest rates, similar to the economy, but you also have other papers who look at this and think that it didn’t really do anything. There’s a very interesting meta study on this, that is a study of studies that shows that, you know, if you work at a central bank, and you write a paper on QE, you will show that QE is a great thing does a lot of things. But if you don’t work in a central bank, the paper results do get show that QE doesn’t do anything. So there’s that as well. So you have to keep that in mind. There’s an incentive there. So now, so today, though, of course, QE is, is over and the Fed is trying to shrink their balance sheet. So what I think is happening is that, one is that this is actually exerting an upward pressure on interest rates, because it increases the supply of Treasury securities. And secondly, I don’t really think it’s having too much impact on the rest of the balance sheet system of the banking system, simply because right now, the banking system has a lot more cash in it than than it needs. So quantitative tightening so far, I think is gone really well, over the past few over the past couple years. As you noted, we’ve shrink the balance sheet down by a trillion, and everything seems to work really well. So it seems like things are going as planned. And I think he could continue for another year to

Eric Chemi 21:39
explain how the balance sheet really works. Right? How does it affect inflation and the economy? Because it’s idea that okay, they’re holding these things, often they’re holding US Treasuries, but it feels like, well, the US government is borrowing money in the form of treasuries, bills, notes, bonds, and it’s the Fed that is buying them or holding them, but they’re just another part of the government. So explain that. That relationship, it just feels like it just recreating money to move from one side to the other. What is that? Really,

Joseph Wang 22:12
I think you’re touching upon the key part as to why quantitative easing was not hyperinflationary the way many people expected and was first rolled out. So the Fed prints money out of nowhere, and goes out and buys Treasury security, right. So at the end of the day, it’s kind of like, you know, printing $100 bills and taking it out and buying another $100 bills. So can

Eric Chemi 22:35
I cut you off for one second? When when you say and so the Fed is printing the money, or the Treasury is printing the money for help our audience understand who can print money on Let’s kill them both commercially.

Joseph Wang 22:44
When they create loans, they’re called bank deposits. And the Fed can print money, they’re called reserves. And that’s how the Fed finances all its purchases, it creates reserves out of thin air reserves are just money held for no money for banks. So their deposits at the Fed. And commercial banks can have a deposit account at the Fed. And so when the Fed is printing money, they’re creating reserves out of thin air, and they’re using that to buy, let’s say during quantitative easing Treasury securities. But think about it. From an investor’s perspective, let’s say that I have a million dollars worth of treasuries, I sell it to the Fed, the Fed prints money out of nowhere and sends it to me, at the end of the day, in my investment account, I have rather than a million dollars in treasuries, I have a million dollars in deposits, my purchasing power doesn’t change, fed credit a whole bunch of money, but they use that money to buy something that was very money like to begin with. And so that that action of quantitative easing, what it really does is that it changes the duration profile of, of guests risk free assets in the financial universe. So if you if you are someone investor who sold treasuries to the Fed, you don’t actually have more purchasing power. So it sounds like the Fed is printing a lot of money. But you don’t actually have more purchasing power, which is why it wasn’t hyperinflationary. However, if you have, let’s say, a million dollars in deposits, rather than a million dollars in Treasury securities, giving you some interest rate yield, maybe maybe you reshuffle that a little bit. Maybe you don’t want to have 0% yield on your deposits. So you go out and you buy a corporate bond, by celebrities and so forth. That proposal rebalancing channel has it’s over the years shown to be very risk positive, but not really inflationary. Now, to your point about the consolidated balance sheet, that’s a really good way of looking at the world. So we have the Fed, they have a balance sheet and we have the US Treasury who has their balance sheet. Now, wind, if you combine the two together what and the Fed is doing QE well, you can think of it is basically a big debt swap or rather, just a debt operation where the fact that you can sell The government is changing the industry profile of their liabilities. So instead of having a 10 year treasury, they have an reserve, which is just a deposit. It’s an overnight is an overnight loan to a bank. So you’re basically just changing the interest rate profile of the United States government to be more shorter, shorter duration,

Eric Chemi 25:22
it almost seems like magic, right? It feels like, hey, we can create this money help the Treasury, but it’s not inflationary and everything is good. But yet at the same time, they’re trying to get out of that business. Right? they’ve shrunk by a trillion dollars. Yeah, how far or how far low? Man, we’re looking at a chart here. And we’ll probably get this posted. You know, we were at, call it a trillion dollars, right? Sort of pre 2008. Right around number, then we seemed like it was a big number to show it, then it became 3456789. And now we’re getting back down to eight, we thought 2 trillion was big. And now it seems like we’d be happy down to 5 trillion, right? What’s even possible here? Can they even get that low? Can they go? Can they unwind the clock a little bit? And if so, what are the impacts of that? If like, you’re saying, Hey, we could buy all this. And it’s not hyperinflationary, right. But then, but then what happens when

Joseph Wang 26:15
you unwind it, you’re extending the duration of your liabilities. And you that’s, that’s a problem, because you have to go and find people who are willing to buy longer duration, Treasury liabilities

Eric Chemi 26:26
to dump these treasuries back on the market. So selling, but what

Joseph Wang 26:30
happens is that the Treasury then goes and borrows from someone else, and takes that money and repays the Fed. So in a sense, the Treasury has to go and issue securities out to the private sector and take that money to pay back the Fed. And that increases the amount of the supply of Treasury securities to the private market. So in the functionally, it’s very much like selling except a key difference is that it’s not the Fed, that decides the duration that the market has to hold, it’s the Treasury. So if it was the Fed going out and selling treasuries, they can decide I should sell 10 years to 1020 years, 30 years. But it’s not doing that. So it’s the Treasury that decides what kind of new issuance they’re going to do. And that is what the private market will have to absorb. And so far, it looks like the private demand is, is a little bit lower than expected. So you can see the term premia that people like to do when they measure Treasury securities has been expanding. And so that suggests that the private sector is looking for more compensation before absorbing duration, you

Eric Chemi 27:32
are looking at that now where it’s the Treasury there’s these fights these risks of are we going to have a failed auction, right? Or are not enough people going to want to buy these bonds from the Treasury. And this idea that there’s so much supply that they’re putting out there that people don’t want to pay as much, right? So let’s call it on, let’s say, a one year, you pay $95 to get a 5% return when you get back 100. Right? So maybe people say I only want to pay 94, or I only want to pay 93. I want a 6% or 7% return, I want a bigger return before I get involved in this, because there’s just so much supply. How so I would say how, how bad do you think this could get in relation to how low do you think the Fed so

Joseph Wang 28:15
it’s not, it’s not all going to be about the Fed, a lot of this is going to be determined by how Treasury issues their debt. So Choji has some discretion as to where it issues along the curve, it can issue a lot of short data debt, which the market can easily absorb without too much difficulty, or can issue a lot more farther along the curve, let’s say in the 30 year segment, tenure segment, where there’s a lot less demand. And so if it decides to focus its debt more towards the short dated side, then it can issue a lot and it won’t have too much impact on interest rates. And it’s been, but it’s been weighing its issuance towards the shorter side over the past few months. But at the end of the day, though, the amount of debt it has issue is very large, because the deficit is large, and also because of quantitative tightening. So it seems like going forward, you’re just going to have Treasury interest rates continue to trend higher, until you get to a point where you know, maybe maybe the Fed is will have to step in for financial stability reasons. But I don’t think we’re there yet. We could get there in the next couple of years. But but not yet. By the

Eric Chemi 29:21
way, I’m curious about these target rates, we used to have a pinpoint precision, right? It’d be like we are at one and a quarter or you have a specific number. And then when we get to zero became zero to a quarter and then this 25 bibs range stayed true even now, what is that relationship between the Fed and the banking system that that they still need to keep this range and they can’t pinpoint exactly what they want hard to

Joseph Wang 29:44
it’s hard to pinpoint. Right. So so if we had a pinpointed rate what would happen is you would have someone on the open markets that are trying to fine tune it. That’s that’s really hard to do today. So back then the implemented monetary policy in a different way. What they will do was they will adjust the supply of reserves in the system to try to try to move the federal funds rate. Today, the monetary policy is different now. It’s really done through administered rates. So they have at the bottom of the range, they have the reverse repo facility rate. And at the top of the range, they have the standing repo facility there. So it’s just implemented in a different way. It’s I think it’s hard to have that degree of precision when you’re doing monetary policy through administered rates range, the rather than just adjusting reserves back when we had a very, very small risk scarce reserve regime.

Eric Chemi 30:35
You mentioned, the idea of the short term issuance right now. And they could the Treasury can decide to the one issue 10 years, 30 years, like where do they want to be on that curve? And there was some debate recently about should previous people who had the job before Powell should they have isn’t really the Treasury side? I’m sorry, that should the Treasury the job that Janet Yellen has now. Right, and the job that used to be hers, right? The job that she has now, like I’m getting Congress here, the people that used to be Secretary of Treasury, they could have issued longer term debt when rates were zero. They could have gotten, you know, decades of funding and basically free weights. And there’s been debate of did they do enough?

Joseph Wang 31:19
Stan Druckenmiller is point. So I that would be true, but for the fact what what the Fed was also doing tremendous quantitative easing. So let’s go back to let’s go to a scenario where the Treasury looking seeing that rates are really low, issued a whole bunch of 10 2030s, to try to lock in that low interest rate, while at the same time the Fed would be buying those 1020s and 30s. And in effect, as we discussed earlier, changing the interest rate profile the debt and turtling, turning that 1020 30 year debt into overnight debt. So I mean, the Treasury could have could have issued longer dated stuff, but it would have been undone by what the Fed was doing through quantitative easing. So at the end of the day, I don’t think it would have made a difference. Now, you do touch on a really good point, though, now that so much of our debt is on a consolidated basis is overnight, both through reserves and through the onr P, you know, doesn’t that make her interest rate expense really high? So that’d be something worth watching going forward?

Eric Chemi 32:20
What do you think about that argument that the government doesn’t want the Fed to have high rates, because the amount the budget is, is that we spend, whether it’s on you know, Medicare, defense, and Social Security, and then the rest of it is just interest payments on the debt? Right? So if interest payments go up, we just bankrupt ourselves to pay interest on our own debt. And then maybe there’s a little bit of a nod, say, hey, fed, let’s keep these rates lower, because we literally can’t afford to pay the interest on it. What do you what are you hearing sowing the seeds about that idea? We

Joseph Wang 32:55
don’t I don’t think we have to go behind the scenes about that we can just go and listen to what Congress is doing. And you know, when I when I listened to Congress, I don’t really hear people saying that, I gosh, we’re spending too much money that that doesn’t happen. So I I don’t see any evidence that Congress is concerned about our interest rate expense or any type of spending. So I don’t think that impacts what the Fed is doing. But I think though, that we can get to a point where in the future where it is becoming a problem, either through very high inflation, when the high maybe the long end goes up too much. Where maybe the maybe Congress would have to take a more active role in monetary policy. Now to be clear, today, we have what we think of as independent monetary policy. But that’s not always the case in our country’s history, nor is it across the world. In many, for example, during World War Two, Congress was best because the Fed was basically responding to Congress. And his job was to cap interest rates to support the war effort. If you look across the world, many times the central bank is simply a part of treasury they do what the executive the electric government tells them to do. So it’s important to keep in mind that this quote, unquote, independent monetary policy is something that happens sometimes in history. And in some countries, it’s there’s nothing special about it. And we could go into a world where, as you, as you noted, where maybe Congress has a greater say in how the Fed sets monetary policy because they want interest rates to stay low. They want the government expenditures to stay low as well. What about the

Eric Chemi 34:29
debate that some people say the Fed is who caused all the COVID inflation, some argument supply driven, the Fed had nothing to do with it. Others say like the Fed fiscal government was way too was

Joseph Wang 34:39
our interest rates, right? That’s what they’re doing cutting interest rates, and then buying tremendous amounts of securities to try to put down longer dated interest rates. So they definitely had an impact on interest rates, sec sensitive sectors of the market. Now, like we discussed earlier, you know, you have house prices soaring 20% year over year now, that’s because mortgage rates were really low and mortgage rates really low. That’s that’s the Fed, that’s the Fed setting rates rates at zero buying tremendous amounts of mortgage backed securities. So you know, if you have mortgage rates and say, two and a half 2.75%, you’re going to have a lot of people buying homes, and that’s going to, you know, Goose home construction that’s going to put home prices up. So that part is definitely I think it’s definitely squarely at the Feds feet. Because it and if you look at asset prices, yes, that’s very much interest rate sensitive as well. So that huge boom, we saw in, let’s say, speculative assets, speculative parts of the financial markets, I think that’s all the feds are doing as well. But there are also other aspects that I think are not the Feds doing. So for example, Gen COVID, we had a tremendous amount of people, baby boomers retiring early, so we had a temporary shortage of labor, and that pushed wages up, right, I don’t think that’s the Fed doing that, that’s just a bunch of people who, for whatever reason, wanted to retire earlier than expected, in decreasing the supply of labor and then pushing wages higher. So that I don’t think the Fed did much to do that. Maybe they use the stock market so much. So a lot of people retired earlier than expected. But that’s an indirect impact. Again, we also had the fiscal side, sending people a lot of free money and going out, and basically just doing a whole bunch of fiscal stimulus actually buying goods and services. So that’s going to have a big impact on inflation as well. So when I look at the whole picture, though, you know, if you take out the housing aspect, looking mostly on the real economy, inflation, I think most of it has to do with fiscal policy. When demographics rather than the Fed. Again, they all have a role to play. But I think the Feds role is is more limited to these interest rate sensitive segments of the market, which is just, you know, 111 slice of the pie, you know,

Eric Chemi 36:47
there’s an argument that the Fed’s balance sheet is holding all of the losses on bonds, the losses of mortgage backed securities. So it’s, the argument is that it’s insulating the private sector, the private sector is almost getting a little mini bailout, they don’t suffer the losses of these of these instruments. So as a result of Petoskey hiking rates, that’s hurting the housing market, so forth. Do you agree with that? And do you think the balance sheet balance

Joseph Wang 37:10
sheet has impacted rate hikes. So one of the channels through monetary policy works is through financial conditions, so or you can think of it as as the wealth effect, which they’re connected? So let’s say that the Fed hikes rates, and I’m looking at my investment portfolio, I own stocks, I own bonds, my bonds, you know, they’re going lower in price, because the Fed has hiking rates, I feel less wealthy, there’s more, I spend less, there’s more stress in the markets. And so that impacts demand and so that can slow down the economy. Now, how interest rates feed into equities that’s that’s kind of a hard thing to say. Because equities a lot of it is emotional, a lot of it is sentiment, but how rate hikes feed into fixed income. I think that’s a lot more sure. So fixed income, you know, it’s it’s very sensitive to where the how the Fed is hiking rates. So it’s fed hikes rates, you can mechanically expect a haircut on your fixed income assets, you will have losses on your fixed income portfolio, you will be less wealthy, you will maybe not spend as much money as you as you would have. Now, the amount of losses that the Fed can inflict through rate hikes is going to on the fixed income portfolio is going to be in proportion to the amount of fixed income securities the private sector holds. Now, when the Fed went out and bought a whole bunch of treasuries, that means that the private sector is holding less fixed income securities, because the Fed bought it for them, and they bought it for them. So instead of holding these treasuries, the private sector holds these, let’s say deposits, which don’t have any duration risk. So now then, when the Fed hikes rates, those securities decline in value, the wealth effect, it’s felt on the Fed’s balance sheet, because the Fed took away that that interest rate risk, and the person who sold the security the Fed they’re not, they’re not impacted. So that decreases the negative wealth effect of interest rate hikes, and I think that made monetary policy a bit more difficult, bit less effective than otherwise would be. So I think that that makes a lot of sense to me. You help

Eric Chemi 39:21
us understand now what’s going on the last couple of years at the Fed their thought process, the people involved their interactions with with government and banks, other stakeholders. So putting that all together, what is the investment opportunity for somebody right now, where do they take this because a lot of debates are, are we headed into a recession? Is it a soft landing? Do they have another hike in them is it you know, higher for longer and they hold and they only cut if there’s a problem? There’s still so many questions, even if they said Feds not going to change anything for a year. That leaves us with still a lot of questions right even outside of that What are you telling people in terms of the investment point of view here?

Joseph Wang 40:03
So first off, I think we should rewind a bit when, just a year ago when the Fed was hiking rates, and everyone was saying, the economy can handle these high rates, you’re going to have a deep recession. And now, today, a year later, more recently, GDP grew at a annual pace of 4.9%. So that is, you know, that’s bonkers. And at the same time, it looks like equity markets are, you know, quite buoyant. So we have to be, we have to be careful when we look at the world, sometimes things don’t work the way that we think they do. Now, the data so far for the past year has very much been showing a soft landing. So just rewind again, Chair Powell year ago at Jackson Hole was telling you that he’s going to rake rates and there’ll be some pain, he was thinking that he would cause a recession, and that would get inflation down and raise unemployment a little bit. But so far, though, inflation has been coming down again, we had a soft CPI print today, it looks like it’s trending towards the Feds target. At the same time, unemployment has stayed around multi decade lows, and growth continues to be above trend. So so far, very much, it seems to me that we’re on track for a soft landing, we’ve been on this trajectory for several months now. So I think that’s actually really positive for asset prices, because going forward, the extra my expectation is that the Fed begins a cutting cycle next year, not because they’re trying to stimulate growth, but because inflation is lower. And as we discussed earlier, they’re trying to maintain real rates. So I think this rate cuts beginning of a rate cut cycle will be very bullish for just for for for the equity markets. Now, at the same time, though, even as we have, even as we have inflation trending lower, we still have the federal government who has a very large fiscal deficit, they’re spending, let’s say, fiscal deficit around 7%, which is usually what you see during war times or during deep recessions, not when we’re already growing above trend. So you’re going to have a lot of fiscal spending, that’s going to be a tailwind for for growth. So going forward, I think it’s going to be a very positive, positive year for risk assets would have lower rates, and you’re going to have this huge tailwind of fiscal spending. And as rates go lower, you could have all these interest rate sensitive sectors of the market begin to pick up again. So you know, I think I think the equity markets in general, are a good place to be

Eric Chemi 42:30
what is the number one question people ask you? And they find out, you’re the Fed guy, or you worked at the Fed? What is the number one question people weren’t

Joseph Wang 42:39
really buying stocks? Know the Fed is not buying stocks? There’s, as far as I know, there’s no secret plunge Protection Team. Maybe there’s someone secretly somewhere, has been buying the buy button. But now that’s that’s not what the Fed does. But it’s very transparent. I don’t I believe that they’re trying to do the best that they can. I don’t believe there’s any other hidden hidden motive or hidden operations that are that is not public.

Eric Chemi 43:11
If you were the chairman of the FM FOMC, the Federal Reserve all what would you be doing Joseph weighing is now replacing Jay Powell. What happens on day one or day 365, actually, I think,

Joseph Wang 43:24
is doing a good job. So to be clear, as I mentioned, before, we are on we have been on the Southland the track for several months, I think what we what I would do if I was Fed chair is I would cut in March and gradually cut as inflation trends lower. Now, I suspect, though, I suspect that inflation is going to stabilize at about, say, three, three and a half percent. What I would do in what your pal has not been doing is that I will be more vocal to Congress about the need for cooperation and getting inflation down. Now inflation is the Feds responsibility. But the Fed, of course, cannot do this alone with interest rates if the Congress continues to spend money. Now, when you’re juggling around interest rates, you can toggle demand. Because, logically speaking, if interest rates go higher, maybe people will spend less money. That’s only true for private citizens. It’s not true for the government, who, as we’ve seen over the past couple years, doesn’t really care about interest rates, they just spend. So I would be more vocal and noting that fiscal deficit spending is making it difficult for them to get inflation under control. Now, the curious thing is if you look across history, former Fed chairs very vocal about this look across the pond president regarding the ECB goes on stage and says that I’m trying to get inflation under control, but Oh, you guys keep sending stimulus that’s making my job hard. So what what the what what chair Powell will is doing and this reticence in mentioning this, I think is very surprising, and it might actually foreshadow what we’ve been talking about earlier, and that may be going forward. The Congress will have more power in setting monetary policy, because the Fed just politically is not as strong as it used to be. How

Eric Chemi 45:05
did you go from being a lawyer to being a traitor on the Fed, unless I’ve got the ordering wrong, I was talking about the shift that I was,

Joseph Wang 45:12
I was practicing law at a law firm in New York. And I didn’t like what I was doing. Not that there was an underground work, it was just really boring. So being a lawyer, you know, you’ll see it on TV. And you guys can watch that a lot of a lot of lawyer TV shows. It’s not like that, in reality, you are basically writing term papers for the rest of your life, sometimes late into the night. So it was really boring, I wanted to do something more about more, connect more about figuring out how the world worked. And so when I looked at financial markets, that seemed really interesting, to me, it seemed like if you were in the markets, you’re kind of connected to everything that’s happening in the world. And it was kind of like a puzzle that was always changing. So that seems so much more interesting to me than figuring out whether class three worked with class four, a, and so forth. So I wanted to do something in markets, but it was a hard transition to make. Because, you know, after I graduated, I graduated in 2008. And you know, since then there was a great financial crisis, and it was not a good place to be in the markets. Eventually, though, what I did was I went back to school, got a master’s in financial economics worked in as a credit analyst for a bit and just applied for a job at the Fed. And they they liked my background, I guess, doing a lot of quantitative stuff as a credit analyst and just gave me an offer. And so that’s how it happened. And a lot of it is just, I guess, luck.

Eric Chemi 46:39
And, you know, what should somebody read if they’re curious to learn more, right, like, well, what is a book or, or a leader or, you know, biography or something nonfiction? What’s something that inspired you that you think, you know, people, I

Joseph Wang 46:51
think if you ask the clerk, you’re interested in the markets, I would, there’s a lot of really good books, none of them. Definitely don’t read the textbooks, those things they learned in school, they’re not useful. I would prefer books written by market practitioners. So you have the market wizard series, where you where you actually talk to real people and see, see what they’re like, like reminiscence of the sock of a sock operator. Again, a lot of real life experience, but but people who actually work if you’re actually interested in the financial system itself, how the Fed works, and how that monetary policy is made. And I’d be remiss if I didn’t mention central banking one on one, which you can find on amazon.com best seller in that category. You know,

Eric Chemi 47:30
we’ve got the the sort of generational heroes and and all those like the reminiscences of a stock operator, and now see something current, I was gonna say, what about your books, your information? Where can people find more?

Joseph Wang 47:43
If you’re interested? If you’re interested in short thoughts? Well, I have, again, if you’re interested in central banking, you can order the financial system, you can check out my book on amazon.com. If you’re interested in my latest thoughts, I’d write a weekly research piece about what I think is happening in the financial system and what I think the Fed is doing and so forth. It’s on my blog fed guide.com. And of course, I also have a YouTube channel. It’s Joseph Wayne, where you have a Weekly Debrief on what happened in the markets. It’s not as awesome as Wealthion. But check, take a look.

Eric Chemi 48:15
Now, here’s his here’s his very good, I’m glad to have you on Joseph. This has been fantastic, really appreciate you being so patient with with a lot of my basic questions in terms of how does it work? And what are these guys thinking? It? It certainly has clarified for me, because I’ve had a lot of these questions at home. Like, what are they thinking? Why are they doing this? Right. So I appreciate getting the getting those contextual information. I think hopefully the audience can appreciate whether they agree or disagree. Right, I think the Fed is certainly a behemoth to be reckoned with and who don’t fight the Fed, so to understand their thought process, and that mentality certainly can help people. Absolutely, Joseph, thank you so much. Come back anytime. We’ll see you soon. Everybody. Thank you so much for watching this episode. I know a lot of you are watching and thinking maybe I need to get some financial help to figure out how to invest in your future, your family’s future. If you’re already working with somebody that you trust, that’s great, excellent. Stick with them. Keep working together. But if you’re not sure you have the right person, you don’t have anyone helping you at all. Perhaps consider scheduling a consultation with a financial advisor that Wealthion endorses that’s at wealthion.com There’s no strings attached. You’ll see the short form on the website, it only takes a few seconds. Like I said, it’s totally free to have these consultations and there’s absolutely no commitment to work with these advisors. Wealthion provides this resource as a free public service. They’re looking to help as many people as possible get their finances on track. And if you enjoy this video if you enjoyed this conversation of Joseph and I please like the video, subscribe to the Wealthion channel forward share all of those good things that really helps us and it helps get this video content out there the podcast content out there so that more people can learn and be more equipped for their investments. Thank you again for watching.