Good afternoon. Thank you for joining the Professor Siegel on the Markets webinar where you'll hear from Professor Siegel, WisdomTree Senior Economist, Jeremy Schwartz, Global Chief Investment Officer, and Kevin Flanagan, Head of Fixed Income Strategy.
Jeremy Schwartz:
Well, yeah, and thank you Kaleigh for helping us. What's on your mind Professor? It's been a busy week for you. I know a lot of calls about your early morning CNBC call on Monday. A lot of people looked at that market and said, "Oh, is the professor panicking? Is the Fed going to be panicking?" I love your take on what's happening here. We'll get your updated thoughts on how you're reacting to the latest data in your current call.
Professor Siegel:
Yeah, thank you, Jeremy. Well, things are more comforting, certainly now. I mean, particularly, you know I like the jobless claims as an indicator, and it did go down. That is good. And I have to take some responsibility. I didn't want to say things are falling apart or crumbling. What I wanted to make forceful, and I am going to make it still forceful, is that the Fed is not following its own stated monetary policy. It's not following any accepted monetary policy. And all the data suggests that the Fed funds should at or below 4% now. So when I said 70, I was trying to think, well, how do I get it down to 150 basis points? Well, let's do 75 and then we'll do 75 September and we'll get down to exactly where we'd be.
I just am very sensitive to the Fed falling behind as they dreadfully fell behind on the way up. I just don't want that to happen on the way down. And when he didn't move on July and said 50, we never even discussed 50 basis points as a drop in September, I began to worry that it's just going to go down way too slow. Now, I have some slides that I want to share with you that I think will illustrate my point over here. And let's get to a presentation mode over here. Yeah. All right.
Okay. Is Fed behind the curve? Yes, by its own criteria. And I'll explain that in a moment. Fed has overshot the unemployment target and is only a half a percentage point from the inflation target. Virtually all policy rules dictate a much lower funds rate at 4% or less. All right, let me just show you the Fed's own projections. This is, as you know, the quarterly SEP report that comes out every quarter. It is a dot-plot plus projections. It's the basis of the Fed actions. We will, of course, get one in the September meeting. This is the last one of the June meeting. I want to show you the anchors. You see the border in this orange rectangle over here. The Fed believes long run GDP growth is 1.8%. They believe that a normal labor market, not too tight, not too loose, is 4.2%. By the way, the March number is just below it. The June latest number is just above it. 4.2%.
If you are under that, you need to tighten because that could cause inflationary pressures on labor. If you're above it, technically you should loosen, because you're above the long run target. Well, on Friday we blew above 4.2%. We went jumped from 4.1% to 4.3%. Now these are all matters of 1/10th of percent. I know some people explain it away as an increase in supply versus demand. Although people have looked at it, said, "Yeah, we had big increase in labor supply in the sixties also, and yet we still use this criteria."
On the inflation front. They use PCE there. They do an overall and the core, of course, their long-term target is 2.0%, so that's why you see it there. We are now at 2.5%. So we are above target, but not very much. We've come down from over 8% on PCE inflation to within a half a percent. So we've gone 90% towards the PCE target. We've overshot the unemployment target. All right. Now go to the bottom. The bottom is the long run Fed funds rate that they think is appropriate at 2% inflation and 4.2% unemployment. It is 2.8%, having risen from 2.6% in the March meeting. Now, maybe it has risen another 2/10ths. Actually, that's a big change. Those numbers have not over time changed very much. But even if it's 3%, given that we've overshot on the unemployment and we're within a half percent inflation, we should be just 3.5%. Certainly under 4%.
Now, these are the Fed's own numbers. The Fed's own numbers. Now, those who look at monetary policy, there are many- Look at monetary policy. There are many different models. The most famous, I'm sure many of you out there have heard of it, it's the Taylor Model, there was also an adjusted Taylor Model that's in blue. Now, let me just show you what this is over the last five years, four years. The actual Fed Funds Rate is this black line here, actual. Well, you can see how far the Fed fell behind in 2021. I mean, never before had I really seen. You have to go back to the terrible monetary policy of the seventies, of Arthur Burns, et cetera. You have to go back a half a century to get a deviation that big. As you can see, the Taylor view, all the other ones, a balanced approach view, the shortfalls view, all that, they were giving. The only one first difference, and I'll talk about that in a moment, were always saying that you should have gotten 8%. They were at zero. Then they finally raised it.
But look where they are today. By the way, this is before the employment report on Friday. I did a little back of the envelope calculations, and they all would've fallen below 4%, except for something called First-Difference approach. It would've fallen below where they are today. That's a very controversial one, as you can see, does not follow these other approaches that are more traditional here. But they're all at 4%, actually having fallen below 4% if you take the increase in the unemployment rate that we got on Friday. So, why has the Fed not moved? It's opening up a gap. Now, to be sure, this gap is nowhere near as big as the gap it had before. But if we get any more weakness in the unemployment rate or down on inflation, it will be opening gaps of sizable areas, that's why I said.
Now, he's not going to do an emergency cut. Certainly the data does not say you have to scare people. What I'm saying is, his own data here says that he should be within 1% of 2.8, the long run Fed Funds Rate. All the model data done by economists, John Taylor was Secretary of Treasury, he was brooded to be actually... He was very close to being Fed chair, very well respected, probably the most famous of all of that, is now below 4% as what he says it should be. Now, again, this doesn't mean that today or tomorrow the economy's going to fall apart. It means you're unnecessarily tight at the present time.
Then let me just finish up by showing a graph that I've shown before. We were going 5.3% a year, 5.4%, for 34 years we were increasing money at 5.5%, which is very consistent with two 2.5% inflation and two to 2.5% real GDP growth. Then we exploded the money supply after the pandemic, and continued. This is a detail of that. Then slammed on the brakes in March of 2022. By the way, the increase from March of 2020, which was the pandemic, to March of '22, is the biggest two-year increase in Fed history, 110 years of history. We slammed it down, which was the biggest decrease in 85 years. Since then we've had very, very tepid money growth, only 1.5% over the last 15 months. There's been a little bit of an acceleration in the last three or four, but that rate of growth is still 2.5%, which is only half of what I and many other economists think is necessary for liquidity growth in order to keep the inflation at 2%, and allow for to two to 2.5% real GDP growth. So, how do you create money here?
Now, this is not quantitative tightening or reasoning, that's working on the monetary base. On reserves a different mechanism. Yes, it does affect this number, but indirectly. The way you affect this number most is if you want to increase the money supplied at a more rapid rate, you lower interest rate, that encourages people to take out loans. That's how money is created. Demand, deposits, checking accounts, now accounts, savings accounts, CDs, money market accounts and all that. You want to restrict money, you raise rates and that causes people to pay back loans and not to take out new ones, and therefore deposits go down. So, that is the mechanism through those rates here. All I really want to say here is that, what model is the Fed using to direct its... I mean, if it's waiting until the inflation goes to two, even Powell himself has admitted that's too late.
I mean, the data to me is very persuasive that you should move more rapidly. Listen, when he finally got the message, listen, let's go back to what happened here. I mean, these were 75 basis point increases. So, then when finally realizing how far behind he was, he began to speed up. But by then the damage had been done, the money was out there. Remember the money, this was way excess amounts of money. You can see that, it just ramped up and then continued up and all this was inflation. All this went into inflation. Very classical, nothing puzzling about it. Slammed on the brakes, tepid since then. We're not going to bring prices back down to the level pre-pandemic, although a lot of Americans would certainly love to do that. It ain't going to happen.
The most important thing now is accept what has happened. Slow inflation 2%, but don't squeeze it down to a lower rate. So, that is basically what I wanted to get into the conversation, and ask Jay Powell, what criteria are you using? If you are so close, 90% on one, overshot on the other, of the two mandates that you have, that you haven't moved one basis point yet in easing credit. Let me stop the share and we can go back to that if you'd like.
Kevin Flanagan:
Professor, I'd like to start off, I mean we are talking now, it was all inflation, inflation, inflation. Now we seem to be more balanced with the dual mandate. So, a couple of questions came in. I guess kind of interrelated. The first was, "I remember when full employment was 5.5%, A, what happened? Then B, what would you think in an environment that's non-recession, soft landing, soft growing, what would you consider to be okay monthly jobs numbers?
Professor Siegel:
Well, I think the Fed is particularly right. I think 4.2, given the structural changes in the labor force, is the proper long-term, not too tight. I mean, right now we're pretty much in balanced job openings, quits, et cetera and so on. I know the JOLTS report is still a little bit tighter than it was beforehand, but we know a lot of people are putting out those job openings even when they don't really have them. We're getting a lot of government and healthcare. I mean, that is taking the lion's part of it. Very little outside into the manufacturing in the other areas.
I'm not saying that... I never said that was a recession and I certainly... I regret giving the impression, "My God, things are falling apart. Do an emergency." But I just want to get on that table. But I think 4.2%, Kevin, in answer to your question, is the proper number. They have had 4.1, 4.2, 4.0, I mean within a 10th of that for years and years and years. I think that that is proper. So, we are there, we're at the balance and if not slightly loose on that, and on the unemployment. We've moved 90% on the inflation. We have lagged effects of monetary policy. So, this tightening, it's not concurrent, it's lagged.
Even with the shock treatment that came in late, it took a while for that inflation to begin to actually move down. You don't wait until the end. In fact, that's what Powell said. So, we are going to have residual inflation in the service sector. Service sector inflation is always 2.5, 2.75, 3% because there isn't as much productivity growth in the service sector because it relies more basically on just hours put on labor. Productivity growth in the good sector is bigger, so you're never going to get the service sector to be down to-... bigger. So you're never going to get that good, the service sector to be down to 2%. I look at not only money supply, we look at commodity prices, they have come down, all the general commodity indices are really in, I don't know, I'd call it a slump, but almost a bear market, more than 20% down from their peak. That's something I absolutely look at. I mean, what's happening to those sensitive commodities? I mean, even oil, even despite the Middle East tensions is down. But the other commodities are also down. So I don't see excess demand anywhere, and I just want to make sure that we don't commit the same mistake on the downside that we committed with the way on the upside.
Jeremy Schwartz:
There's a few people who wrote in and there's so many different themes of what we could do. Maybe I'll go to equities for a moment. There's a few of the themes, we had two different questions on small caps, small cap value as part of what's going on and the rotations that we see. Is that part of if you see the Fed reacting or how do you look at that story where it is today?
Professor Siegel:
Well, I think the story is that high short-term interest rates hurt small firms far more than they hurt large firms. Small firms finance at the short rate much more. They don't have the ability on the equity side as easily and certainly not on as cheap equity cost terms as those large firms do.
A lot of the large firms were always able to convert their debt long-term during that period of low interest rate. They've locked them in for 10, 15, 20 years. That was not as available to many of the shorter-terms. So really, when the Fed tightens and loosens, it affects the small called firms more, and obviously the interest sensitive firms more. It's not a neutral process.
So my statement is many of them, of course, it used to be called LIBOR. They pay two, three, four points above LIBOR for their financing. Now it's SOFR, the Secured Overnight Funding Rate, which has replaced LIBOR, but it's the same thing. You pay over and now that's the collateralized rate on actually treasuries. So they're paying two, three, four points right over that. And that's all short-term treasuries and they move exactly with the funds rate.
For those who can finance long-term, the Fed can talk down the long rate and provide ease on that, and that will help those industries and those firms that finance long. But those that are financing short are still paying higher and higher real rates. As the inflation rate goes down, the current stance is restrictive.
It's almost like Chairman Powell wants to see the bottom fall of the labor market and then he'll do it. Why wait when all the models and your own stated goals tell you that you should be closer to the long run that you yourself put on paper in June? We'll see how it comes. I expect it to tick up maybe a 10th of a point. I don't know if it'll actually get to three or not, but even then, we're way above that at the present time.
Kevin Flanagan:
We've done a lot of talking. I'm sorry, Jer, I was just-
Jeremy Schwartz:
I was going to ask a question for you also because one of them came in on fixed income and saying if you believe the people will follow the professor's advice, how would you position in fixed income or just maybe that's just a way to give a comment on where that is going.
Kevin Flanagan:
Yeah, I mean the fixed income are going to go, I mean the fixed income are saying the Fed is going to lower it clearly, and that's why the long bond fell really sharply. I mean Monday it looked much worse than today. With the jobs, the data, it looks much better. I know the GDP report, the Atlanta Fed GDP report is in the upper twos. They generally tend to be on the overly optimistic side. Most of the professionals are in the lower twos at the present time. But don't forget, we just finished one month of data. We got to get a lot of data coming in.
And I'm not saying things are falling apart. I'm just saying that if the Fed had a consistent rule, we would be much lower and without inflationary threats. The idea, by the way, and I want to go back to this slide just for a second here, because the idea that, let me get to this, that we could reignite inflation is just not anywhere in the data.
The 1970s, this is the 1970s. There was not a single month in the entire decade, 120 months, where the money supply fell. Arthur Burns just kept on pushing, pushing, hoping it could offset the contractionary effect of the OPEC oil embargo, which of course was just really putting fuel on the fire and causing the stagflation. But the money supply increased at 9.6% a year during that period and we have nothing like that going on.
So the idea that a cut, which oh my God, all of a sudden we're off to the races again, there's just not the liquidity or the money for that. There was in the '70s. And in fact that's when money supply rules became popular was they saw that the only way to really control that inflation, Volcker said, was to bring interest rates high enough to squeeze the money supply down to the 5% rate, which then from the mid '80s all the way to the month of the pandemic, 5.5% per year for 34 years until the pandemic.
So then I know it requires ... Listen, I give the Fed this, this thing here, but from there they should have just increased at a steady rate of 5.5%.
All right, give the liquidity, that's going to push more inflation. But all right. But then he continued to increase it 11, 12% for another two years and then squeezed. And here's where we are now, kind of lackadaisically moving along. I think is not a good consistent monetary policy and I'd like to know what the model is. Here's all the other models. They always say go down and they're further down as I mentioned right now.
I mean from my vantage point, Jer, I know professor, you've talked about this when we look at the yield curve and how a lot of people look at the Treasury 2-year, 10-year, which is almost uninverted, but perhaps we should be focusing more on Fed Funds 10-year or slashed 3-month T Bill 10-year, or throwing that the Treasury floating rate note and the 10-year.
We talked about taking advantage of that and using a barbell type of strategy. Matter of fact, we've been highlighting a money in motion theme talking about that as well and what we should be focusing on.
Professor, I wanted to ask you. We've been talking a lot about rates, Fed cutting rates. But what about the balance sheet? So since they began quantitative tightening, they've reduced the balance sheet by about 1.8 trillion. I checked. The H.4.1, back in the old days we used to call it, used to come out every Thursday at 4:30. We would run down to 33 Liberty Street and then try to get the hard copies. So do you think quantitative tightening could come to an end by the end of this year?
Professor Siegel:
The most important by far of the Fed in the current reserve regime is the interest rate they set. The quantitative tightening honestly does not mean a lot unless it reduces the reserves of the banks as it did in 2018, where they say, "Ouch. Just a minute. I want those excess reserves. I need them." Of course, they created what, 3, $4 trillion worth of excess reserves and they've pulled back half of it and now of course they reduced the pace at which they are pulling it back by ... of course they reduced the pace at which they are pulling it back by 50%, which is a good idea. The reason was that experience. As I've said, it's like a dentist that's drilling, "Well, we'll try this without Novocaine and if we get to a nerve, we'll administer it." Well, they did quantitative tightening and they didn't think they were near a nerve, but all of a sudden they hit the nerve and the bank said, "I need these reserves." And you had all the problems and the funding rate and that made them very cautious, then that's why they went to 50%. But don't forget, they added 4 to 5 trillion. As you said, they reduced a trillion, that's a drop in the bucket. They still have a lot of extra. So how far are they from the nerve? I don't know exactly. Maybe they have another trillion or a half a trillion. It's hard to know how much excess reserves the banks actually want at the present time.
But I have always considered that quantitative tightening to be secondary in its effects of the funds rate. Because the funds rate sets the prime rate, the funds rate sets the LIBOR, the SOFR, the funding rates, all short-term rates, it sets credit card rates. Credit card rates are what, 9, 10, 11 points above the prime rate, which is three points above the Fed Funds target. I mean, all these rates are built on the Fed Funds target and they control trillions of dollars of funding. And therefore to say, "Oh, it doesn't matter, they'll eventually get down there. The two-year tells us they're going to make 8 cuts or 10 cuts of 12 cuts, we should only look at that." Well, that's like saying, "I'll put your head underwater, but two minutes from now I'll let you up," you have to survive those two minutes. I mean, a lot of firms are going to have to survive when the Fed is way above what the economic situation dictates it should be.
Kevin Flanagan:
And it was Maiden Lane, not Liberty Street, my mistake.
Professor Siegel:
Yeah.
Jeremy Schwartz:
A few rapid-fire questions that tie together. Two people asked about, one made a comment about an unwritten rule that before elections you shouldn't take action, something about the election and your timing, and then also a number of questions about the debt and the deficits come in.
Professor Siegel:
Well, just quickly not taking action in September is just as political as taking action when the economy needs it. Being neutral, doing nothing given the circ*mstances to me is not being neutral politically. I don't know which side will gain or lose or whatever, I mean, we could talk about that, but I think the Fed is ready to do what it needs to do and will not be affected in September. Even though I think they're too slow, that could be a problem, but I don't think the election is going to figure in. On deficits, yeah, we kind of had a little poor auction, but I pointed out, and my research says that deficits is not going to be a determining factor on long-term interest rates for the next three to five years. Big problems come in the 2030s, we need to work on that long-term.
The biggest near-term situation, by the way, politically, if you want to talk about it as a whole other topic, is all the tax cuts that expire in 2025 and the corporate tax rate, although it doesn't expire, it's going to be in the mix of all the choices and discussions. Who controls the House, the Senate and the presidency is going to be very, very critical, very much more critical than in Biden's first term where the tax cuts were set to last for seven years and ride through them. So that is, I think, the big topic on politics. Will the Dem surge control of both the House, Senate and presidency? That could rewrite a lot. If one branch is the other way, we got more balance, less of one person or one party dictating all the terms. I think personally that's what the stock market would prefer the most, but a lot of that's up in the air about what's going to happen now, it's so close.
Kevin Flanagan:
So if assuming no intervening move, in about two weeks, we have Jackson Hole. What are you thinking?
Professor Siegel:
Well, that's true and thanks for bringing that up, Kevin. Jackson Hole is going to be a really important speech. Now, honestly, if the data goes as it is now, basically, unless there's a flare-up of inflation next week where we get those, which is unlikely, even 1/10th may not be enough given the labor market, what I think he will do is say that, "We are seeing the conditions for a cut, I'm not going to commit the amount. Whether it's 25 or 50, we will look at the circ*mstances." I mean, it's in the third week of September, so it's a full month or more of Jackson Hole. But I think you will see more definite, "We are moving towards a cut," but he will not commit how much.
Jeremy Schwartz:
One of the market turmoil points we touched on Monday a little bit was the yen carry trade. Somebody wrote in and asking if you think, how much of that's behind us? Would the Fed cutting rates hurt that carry trade and make the situation worse for volatility?
Professor Siegel:
Well, it was obviously, I think, important when the Bank of Japan said they didn't want to tighten into market turmoil. They wanted inflation, they got it, sometimes I think it may be a little bit too much. But Japan is doing well under the weak yen and low interest rates. It's paying with a bit of inflation. So they don't want to suddenly see any appreciation sharply in the yen which would really cut their exports at a time when there seems to be some revival in the Japanese economy. So I would take the Bank of Japan at its word there in terms of they're going to leave things alone for a while. Will the carry trade reestablish itself? It might, but what direction the yen takes, I'm not sure.
Jeremy Schwartz:
Kevin, 30 seconds on the barbell. Christy wrote in asking about, remind us of what the barbell is.
Kevin Flanagan:
Yeah, so essentially it's a laddered portfolio without the rungs, right? I mean, you're looking at either end of the counterweights and on one side we want to take advantage of that inverted yield curve. So Treasury floating rate and for us, our in-house is USFR and on the other side focusing on core duration or maybe a little bit above that. So our enhanced yield Ag, which is Aggy, A-G-G-Y are a relatively new fund for us, we have a seven to 10 year ladder Treasury fund USIN. So essentially you're balancing both sides where you're getting the income without the volatility in the front end and on the other side that if there is further rallies or you want to lock in yield, you can participate in that.
Jeremy Schwartz:
Very good. Well, Professor, it's been a busy week for you. We appreciate your insights, we appreciate you calling out the Fed and giving people what you think they should be doing. So we appreciate your leadership in all these issues. And for everybody dialing in, as the markets stay volatile, we'll try to keep more of these calls on the calendar. But thanks for joining us twice this week, Professor, and we will do it again soon.
Kevin Flanagan:
Absolutely. Thank you. Take care everyone.
Please see the glossaryfor terms used in this video.
Important Information:
Investors should carefully consider the investment objectives, risks, charges and expenses of the Fund before investing. For a prospectus or, if available, the summary prospectus containing this and other important information about the fund, call 866.909.9473 or visit WisdomTree.com/investments. Read the prospectus or, if available, the summary prospectus carefully before investing.
There are risks associated with investing, including possible loss of principal.
WisdomTree Yield Enhanced U.S. Aggregate Bond Fund (AGGY) There are risks associated with investing, including possible loss of principal. Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. Investing in mortgage- and asset-backed securities involves interest rate, credit, valuation, extension and liquidity risks and the risk that payments on the underlying assets are delayed, prepaid, subordinated or defaulted on. Due to the investment strategy of the Fund, it may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
WisdomTree Floating Rate Treasury Fund (USFR) There are risks associated with investing, including possible loss of principal. Securities with floating rates can be less sensitive to interest rate changes than securities with fixed interest rates, but may decline in value. Fixed income securities will normally decline in value as interest rates rise. The value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. Due to the investment strategy of this Fund it may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
WisdomTree 7-10 Year Laddered Treasury Fund (USIN) There are risks associated with investing, including possible loss of principal. Because the Fund is new, it has no performance history. U.S. Treasury obligations may provide relatively lower returns than those of other securities. Changes to the financial condition or credit rating of the U.S. government may cause the value to decline. Fixed income securities are subject to interest rate, credit, inflation, and reinvestment risks. Generally, as interest rates rise, the value of fixed-income securities falls. Please read the Fund's prospectus for specific details regarding the Fund's risk profile.
This material contains the opinions of the speakers, which are subject to change, and should not be considered or interpreted as a recommendation to participate in any particular trading strategy, or deemed to be an offer or sale of any investment product, and it should not be relied on as such. There is no guarantee that any strategies discussed will work under all market conditions. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This material should not be relied upon as research or investment advice regarding any security in particular. The user of this information assumes the entire risk of any use made of the information provided herein. Unless expressly stated otherwise, the opinions, interpretations or findings expressed herein do not necessarily represent the views of WisdomTree or any of its affiliates.
Professor Jeremy Siegel is Senior Economist to WisdomTree, Inc. and WisdomTree Asset Management, Inc. This material contains the current research and opinions of Professor Siegel, which are subject to change, and should not be considered or interpreted as a recommendation to participate in any particular trading strategy, or deemed to be an offer or sale of any investment product and it should not be relied on as such. The user of this information assumes the entire risk of any use made of the information provided herein. Unless expressly stated otherwise the opinions, interpretations or findings expressed herein do not necessarily represent the views of WisdomTree or any of its affiliates.
Jeremy Schwartz and Kevin Flanagan are registered representatives of Foreside Fund Services, LLC.
WisdomTree Funds are distributed by Foreside Fund Services,LLC.
