Forward Guidance: Threat to Fed Independence is Un-Anchoring Inflation Expectations | Jens Nordvig

Transcript

It's tempting to say, okay, we have this incredible pressure on the Fed now, right? We're going to have more inflation in in the next year or two as a function of the Fed overdoing it. But what's the Fed actually going to do? You can have an ironic situation where all the name calling and pal is late narrative actually makes him late. We have a very interesting situation here where the September meeting is kind of like crunch time for the Fed. If there are real issues with, you know, fiscal dominance, debt levels getting too high, Fed independence being in question, I can imagine a situation with >> Quick shout out to today's sponsor, Katana. We'll hear more about Katana's 1 billion CAT campaign later today, but for now, let's get into the episode. Hey

everyone, quick disclaimer before we get into today's episode. Nothing said on Bell Curve is a recommendation to buy or sell securities or tokens. This podcast is forformational purposes only and the views expressed by anyone on the show are solely our opinions, not financial advice. Our guests and I may hold positions in the companies, funds, or projects discussed. Today's episode is a crossost from Forward Guidance. We break down the evolving macro environment marked by waning Fed independence, shifting capital flows, a weakening US dollar, and more. Enjoy. All right, everybody. Welcome back to another episode of Forward Guidance. And I'm very excited to be joined today by Yens Nordvig, who's the founder of Xanti Data and Market Reader, previously

managing director at Goldman Sachs, senior investment associated at Bridgewwater, and head of fixed income research and global currency strategy at Nemora Securities. Yen, great to have you on the show. How's it going? >> Thank you very much. Going well. >> Good, good. I'm glad. Yeah, before we get into it, I'd love to just hear a bit about um bit about you obviously just mentioned a few of your touch points of your career path, but where is your areas of expertise? What do you most mostly focus on? And just high level, how do you think about what your macro framework is? >> I I launched Exante data in uh 2016, right? So, we've been advising um macro market participants for almost 10 10 years now. the anniversary will be

in in January and um we uh really have a combination of of really data centric analysis that's what we do on our our platform. A lot of that data is in the capital flow space. So this year where we have sort of big uh questions around changing asset allocation, it's been very powerful. So, we've we've had a good year so far and navigating those shifts around the dollar and so forth. Uh, but sometimes there are topics where it's hard to have a a super data uh focused approach where it's more sort of thinking conceptually about what's going on. And I think we're going to talk

about fed independence in a moment, right? So, that would be one area like how do you do that with data, right? It's not something you can do super easily in a time serious way. So we need to combine uh like really hardcore aggregation of data. That's what we do for a living, right? But once in a while there are issues where you say, "Okay, I'm going to take a stand. There's something that uh really the market is not focusing on that. Maybe there's no data to track yet." Uh and that kind of thing. So we do both. >> Amazing. Yeah. To your point about Fed independence, it really feels like we're going through this pretty monumental regime shift right now. And the biggest thing I'm trying to ask myself and ask other guests is just a way to conceptually understand this regime and

get past the the news headlines that feel like they change every two minutes to actually derive a signal and start to understand. And to your point like our our sample size of these occurrences are very very small. It feels like the maybe the last time that we were in in a true situation of of thinking through Fen independence was basically like the 1940s and the Treasury Court of 1951. So yeah, maybe with that we could just start off by just trying to understand how do you conceptually think about the situation that we're in and how do you contextualize it with that limited sample size that we have. >> Yeah, I think like when when you have limited sample size like one one way to handle it is you sort of broaden your perspective. Is there is there any situations outside the the Fed itself, right, we can use. So we certainly have

a lot of clients in emerging market space uh in Brazil, other places that have had a lot of experience with uh uh central banks that have been under political pressure in a way that we've not used to in United States, right? And they they've seen that play out. So u I think that has to do with like taking in into account data that's not maybe the most obvious but still has some relevance. So, um I I think that this this is a situation where you kind of have to take a step back and think about what's really going on. What's really going on is that we have a lot of debt, right? So, uh it it kind of came to the four back in well, it's come to the four a number of times over the last couple

of years, right? We've actually often had it happen over the summer where there there's some hiccup in the Treasury market, right? we have a spike in bond yields and um sometimes you can say it was due to fears about the the quarterly refunding sometimes it was about u tariffs or lack of foreign demand for bonds right and and recently it's been probably about the the Fed independence right but the the reason why these shocks are relevant is that we have a lot of supply of bonds we have doubt about whether the market will continue to absorb it right so it all comes down to the debt And then these specific shocks are more sort of essentially shocks that sort of frontload the issues, brings it to the

four right now as opposed to in one or two or three years. And that I think is what we're seeing right now. I think investors around the world still have a memory from April where the Treasury market did something that is uh extremely rare and and scary where we we had uh a negative growth shock. something was happening uh to the growth outlook that was very negative. Equities traded down. Uh the front end traded down in yield pricing in the the Fed was going to do something in terms of easing and then nevertheless the long end sold off at the same time. So um that really left a lot of portfolio managers around

the world with like new questions about the treasury market that they didn't have before. uh because the long end is supposed to work as a hedge against equity weakness when something bad is happening and it didn't work right. So since then we've stabilized but I think the concerns are still there and then we have something new all the time that keeps the concerns alive and this attack on the Fed is is is is the new thing right and um it's certainly something that uh is is is pretty unusual in a in um US context right and um it's also just the nature of the attack right it's not okay would like to see rates a

little bit lower. We can have everybody can have different uh views on that and even within the FOMC we have different views right but rate should be 1% and uh then threats of um legal action criminal investigations and so forth like it's a pretty pretty uh it's not just critique right it's pretty dramatic uh posturing so uh it's really it's really a question of okay how do you handle this new situation like what does it really mean and also I think thinking very carefully through what time horizons are the relevant here so we can go into that more >> yeah it feels like one way to think

about this is viewing the US is as going through this emification moment of of sorts and I'm I'm curious like comparing it to what you just mentioned in early April where we saw a lot of these correlations move towards this notion of effectively like a capital flight rotation where we saw the US dollar was going down bond yields were going higher US equities were going lower. So I is this the right way to think about that? And then if so where where are the biggest tail risks? Is it indeed that the currency could just be meaningfully devalued? And um paired with that is it the meaningful risk being capital flight?

>> This episode is sponsored by Katana. Katana is a DeFi first chain built for deep liquidity and real yield by redirecting chain revenue back to active DeFi users. The 1 billion KAT campaign is live. Bridge and deposit directly into vaults in one simple click and start earning immediately on your Ether, Bitcoin, USDC, and more. Follow the link in today's show notes to get started. We're entering crypto's cloud era and IGEN layer just launched IGEN Cloud to power it. Just like AWS transformed the internet, IEG cloud is a full developer platform that gives developers cloud-grade programmability with cryptograde verifiability on any chain.

To learn more about how the IGEN token is securing a new class of verifiable apps and how to get exposure to this growing class of crypto infrastructure, follow them on X at IGEN layer. As always, investments in blockchain technology involve risk terms and conditions apply. Do your own research. >> Well, so the the correlations changing all the time, right? So the the correlations we had in April, right, uh are not really the correlations we have right now. So uh I think I think what happened in April was that we had we had a kind of shocking tariff announcement with tariff rates that were much higher than anybody feared and then we had subsequently a further escalation right so we ended up

with tariffs in relation to China that were more than 100%. So it was not really, you know, an issue of thinking, okay, we're going to have higher taxes. That was not the issue. The issue was that there was fear that the the supply chains were going to break, right? Because we effectively had a tariff so high that it was going to be a trade embargo and the growth fallout from that was very unpredictable, nonlinear and and dramatic and the market priced that. Uh and then since then a lot of new things have happened, right? So we've had trade deals including this week with with Japan.

Before that we have some kind of new framework with chi with with China. Right? We don't really call it a deal because it's just a sort of negotiating situation. But the bottom line is that we come down from more than 100% tariffs uh against China to uh now 30 right and that's where we are. Uh Japan has a 15% number. So, we still have tariffs, much higher tariffs than before, but we're sort of gravitating towards tariff rates that are much more manageable and are just going to be viewed as a as a tax that's there as opposed to something that's going to break the supply chain.

So, that's a big difference. I think that's why the the equity market can handle it much better and it's the reason why um also the correlations have kind of normalized and um long end yields are still high, right? But we we we've seen a bit more stability in the long end. So it's a pretty different regime now. But what's interesting is that the dollar has not really recovered very much. So despite of these correlations kind of being different, the equity market trading bit different, the long end trading different, the dollar has not really recovered. Right? So uh Euro dollar uh has has traded again around 118 this year, which is very close to the year highs. uh Australian dollar has made a new high against the US dollar um this

week as well. So it's really interesting that we've had this persistency in the dollar weakening trend that has been somewhat divorced from the ups and downs in equities. Right? So that tells you there's something new happening and I think that's also what we can see very clearly in our data that um on our platform we have a whole uh page now dedicated to essentially dollar allocation metrics right so uh we had the dramatic shift in bond flows in April that I would say has has normalized to a significant degree at this point but if you look at global equity flows global equity flows flows uh were incredibly dominated by US flows

uh and actually became even more dominated by US ccentric flows after Trump was elected as a lot of international investors were sort of hoping are we going to do the Trump one trade another time what was a very bullish equity market trend that came out of Trump one so we came into sort of February um and and and the aftermath of the inauguration with just extreme bullish and extreme positioning. And then since then we we've seen very different global equity flow dynamics where it's not so much that you have you know dramatic selling of US equities.

It's just this dominance that you had for a multi-year period actually is not there anymore on a very persistent basis. now um actually starting before the tariff tension so you can almost say February, March, April, May, June and into July, right? So it's it's five months we've had a situation where international equities are getting much more subscription. So that is a shift and that shift to be quite persistent and um that I think is a big change that combined with change hedging dynamics is is is the reason why the dollar is trading differently.

>> Yeah. I did want to ask you as as somebody who's an expert in the FX world about that dollar hedging dynamic because you know just a quick way to think about this is that yes the NASDAQ is at all-time highs in USD terms but if you look in say like euro terms we're still actually down on the year and it feels like a huge theme around that is just looking and and trying to understand how much of these foreign flows that you know to be clear were very overweight US going into January of the start of the year um how much of that was actually hedged on a US basis Because obviously if if you know if you're a a European pension fund and you're long mag 7 and and you're not hedged on your USD, you know, April was really terrible for you, worse than

domestic investors. You got whacked on both sides because the euro rallied so much. So yeah, what's your read on how much of those flows are actually hedged or not? >> So we do a lot of number crunching in that space, right? And it it really depends on on what asset you look at and uh what type of investor you're you're thinking about. And I can also look at my calendar. Uh so my calendar has some interesting meetings in it. And a lot of those meetings that are now planned for August and September are with large institutions that want to talk about hedging and are not used to hedging at all. So I think when you have big shifts like uh the one we've seen this year, it kind of is a wakeup call to a lot of players where okay, maybe they should

revisit their framework. Right? So, we've been through uh a 10-year cycle. The dollar started to rally in the summer of 2014, and it effectively rallied, not every week, but on a trend basis, it rallied until January this year, right? And now we've had a big change. We've actually had the the worst start to a year, like the worst first half for the dollar in many decades, right? So clearly if you're somebody outside United States that for a number of years have had success by running open dollar exposure and now you've had the worst year for the dollar in decades. It makes sense to at least revisit okay is this framework I'm using the correct one. And I think this is

what's happening right now that if you look at sort of the sequence of things I would I would put it in in four stages. So you have a first stage where there's a bunch of hedge funds, very qua fast players in the market that can change their posture in the dollar, right? So that can happen within days. Then you have a group of really professional hedgers that sit and and think about what's happening in the currency market all the time. That would be large pension funds, right? They have specialists that are uh hired to to change their FX exposure when needed, right? And we've seen some shift there in during I would say April and May and then there's sort of a phase where

uh the people who are not used to hedging will have to make uh decisions about do they do they change their allocations and I think that's the phase we're going through now and the final phase actually has to do with what US investors are doing. So, US investors uh have now enjoyed not having to worry about international assets also for 10 years. And I'll I'll just give you a couple of statistics, right? If you look at at all the fixed income ETFs that are issued in the United States, close to two trillion worth of them, there's only 5% of them that actually have international

exposure in them. And within that 5% most of it is hedged back into dollars. They like they had been trying to issue product that is just dollar only right. So we're down to less than 1% of that two trillion that actually has any foreign currency risk. So that's just one example and we have many we analyze capital flows sector by sector down to all the individual companies right this home bias that you have in the US which has grown and which is extreme is prevalent in insurance companies retail really on a very broad basis right so if we're going to get a fourth phase

of you know people changing their dollar allocation. It would really be if the the US institutional and retail community start to embrace international allocations more and that's going to be a very drawn out thing because if you are a a retail investor or a registered investment advisor, there's actually not that many ETFs that that give you that exposure, right? So it will require that the ETF providers actually change a little bit the mix in their offering and um that's going to take some time. So that's how you get like a long tail of this dollar shift, right? Different players move at different time horizons and u yeah that's how you get a trend that is more than a couple weeks, more

than a couple of months because it's just more and more different players that have to make these decisions. >> Yeah, I really love that framework and sequence of events. It it feels like one of the core drivers of this you mentioned capital flows a couple times and I think about is how to figure out the the balance of payment situation and how that's being influenced by tariffs. Obviously one of the the large reasons for these tariffs is to to narrow that that that uh current trade deficit. Um and then also on the other side of that in terms of balance of payments is the capital account surplus. So I'm curious how your firm and also you know foreign allocators that you talked to are thinking about the situation where obviously we don't fully know where the

tariffs are going to land in terms of the final effective tariff rate. But regardless we're seeing this attempt to narrow that that that current account deficit. And then also on the other side of things on the on the capital account surplus side of things, we've seen a couple hints before um in terms of just some of the policies within the big beautiful bill where they've started to talk a bit about you know taxing remittances and and these sort of capital controls effectively. So, I'm curious how what's the right way to think about this potential risk where obviously for decades now it's just been the the the steady grind lower and and widening of that trade deficit and now there's this attempt to to normalize that and how does that get affected into FX and these capital flows that you look at?

>> Yeah. So, there's there's many different elements to your to your question there. There's the trade there's the trade aspect what's happening with the with the trade balance and then there's the capital flows and on the capital flows there's a lot of different moving parts right um there's a cyclical dimension to the capital flows right so if the tariffs uh are going to you know be a drag on disposable income which they will right most of the tariffs are paid by US companies or US consumers, right? So that extra payment is going to be less income they have to spend on anything

else, right? Uh so when the the treasury, my old client Scott Besson, right, is happy that there's more income in the US Treasury, that's certainly good for the budget and those uh revenues are significant, right? But somebody's paying for it and somebody's going to have less income as a result. That's just that's just a fact. Um, so if those tariff effects are big, maybe in the region 1% of GDP, I'm using Scott Besson's numbers again, that drag is going to translate into weaker consumption. We're already seeing that real consumption growth in the United States is is really stalling here. Like we have very little real consumption growth in the first half for

the first time in years. that could feed into the capital flow picture in an important way, right? Because if that leads the Fed uh looking through the independence issue, but from a pure cyclical perspective having to to ease policy to avoid the labor market getting too soft, right? We're going to have lower interest rates and that's going to impact the bond flows and uh especially in a world like we have now where there is some yield. There is some yield to have. So it's not like in 2018 right where yields everywhere else in the world were zero right and the US had a little bit of yield now if the US is lowering their yields like let's say

below 4% towards 3% the yields will be very similar in a lot of other jurisdictions right so the yield advantage will be gone and that's going to have a big impact on the capital flows right so that's that's one aspect of it but the other aspect is this concern about, you know, safety, right? So, uh, I remember we had we had a big, um, chief investment officer dinner in New York. It happened to be the day when the liberation day announcement was made, right? And, uh, market was like in a pretty pretty dire straight. And then, uh, we we were sort of talking about

what's happening in a medium-term sense, right? And I remember there was there was one of the the the chief investment officers from a big sovereign wealth fund, right? He was sitting there pretty quiet the whole dinner and at some point he went on a rant about essentially taxes on on capital flows, right? >> Yeah. >> And it was in the budget bill. It was not the most beautiful part of the of the bill. H and then it was taken out in the Right. But the fact that it was in there until almost the final vote that we were going to have some kind of tax on u certain types of of foreign capital inflow. I think that shows that like

we're just in a much more unpredictable environment, right? Things can happen that we didn't expect before. Uh right now we have a tariff threat against Brazil that is due to political tension. So tariffs are being used in different ways. It's a much more unpredictable environment and that's certainly making global investors just think another time about what is the allocation they want to have. I don't think it generally means that they are like selling tons of US assets, but it means that they're thinking hard about should we diversify and I think that's the process we're in and the US for many investors have kind of been viewed as the only game in town certainly for tech investments, right?

And uh in some period uh in fixed income like the only thing that that people looked at in pension funds was US high yield, right? But we're not there anymore. people are thinking about diversifying. There are yield opportunities elsewhere in the world and this is a big shift from where we came from and something that probably is going to have a multi-year effect and I think that's what we're seeing play out. >> Yeah, I'm curious on that point. Uh it just makes me think about this fact that you mentioned that they're not really outright selling. They're just starting to think about how to further diversify.

And then I just level that up to what's going on at the the foreign exchange reserve level at central banks where it's been really interesting where you see that not if if you look at their FX reserve levels, they're not really like selling down their US dollars, but you're seeing this huge bid for say gold um and those sort of ideas. So I'm curious if you have any reads on how at that level they're starting to think about this diversification. Is it just trying to own more gold? Is it trying to own more euro or or any other currencies? or are you seeing this potential for them to actually outright sell that US dollar FX reserve positioning as well?

>> So, so the the currency reserves by central banks, right, used to be incredibly important in those periods where there were largecale intervention and they're still important, right? because there's potential for reallocation but I don't think we have seen a lot of evidence of any kind of largecale selling of dollars. Uh the exception is is the gold trend, right? A lot of central banks have been trying to increase their gold share uh both from from like letting the valuation effect play out, not selling on the way up, but also adding to flow, right? So that is a reflection of a concern about

traditional reserve currencies. Uh a lot of people refer back to the fact that Russian reserves were confiscated when they invaded uh Ukraine in a full-blown fashion in 2022. Uh but obviously we have these dramatic trade negotiations between the US and all countries in the world, right? And the ones who um really are not very diversified are probably all thinking about is it is it smart to have these tense negotiations with the US and then be fully reliant on on the dollar as uh the only or extremely dominant uh component of reserve holdings? Probably not. So

there's also some need to diversify there. And it's interesting that uh the Europeans which have never really endorsed the euro in an active way as a reserve asset have actually started to do that more and the reason is that a lot of of of governments have big issuance needs right so it's it's a clearer situation now for the Europeans that they actually need foreign buyers of their bonds and therefore sort of endorsing the euro as an alternative reserve currency to the dollar actually is is more uh straightforwardly uh forwardly like beneficial for them now than in the past because they need a lot

of foreign buyers for for buns and so forth because they have bigger issues. So there's a lot of of shifts going on in that space and the Fed independence is a part of that as well. >> Right. If if there's if there question marks around is the Fed always going to be, you know, a hard central bank that sticks to the inflation target or they're going to get softer and softer over time as the debt concerns and political pressure forces them to, you know, be too easy and not get quite the target. that's very relevant for uh for for the holders of of currency reserves and um I think those things are not

something you're going to see in the flows or now they've shifted from Monday to Tuesday in a dramatic way but these are underlying trends you can also see it with gold right we had that signal from the Ukraine war starting in early 22 it took some months before the gold flow started to shift right these are not hedge fund flows. These are long-term semi-governmental flows that react in a slightly different time frame actually. >> Okay. So, just to round out our conversation here on Fen independence and sort of the secondary effects on on currencies, it feels like everybody's waiting for the shoe to drop on this next leg lower in in the US dollar. And I'm curious if you think that the only thing like if

you look at dollar positioning, it's it's very very short right now. So I'm I'm curious if you how you think about is the last thing holding the dollar up right now just this lack of movement from the Fed in terms of cutting and if so if we get to this point you know this time next year where we see I don't know 200 basis points of cuts is is that going to be the catalyst to finally see that shoot to drop and see the dollar lower? How do you think about the effect of the rate differentials of of these changing rates coming lower on the currencies? >> Shout out to today's sponsor Katana. Katana is a DeFi first chain built for deep liquidity and high yield. No empty emissions, just real yield and sequencer fees routed back to DeFi users.

Incubated by Polygon Labs and GSR, Katana is launching with notable ecosystem of primitives, assets, and partners like Morpho, Chain Link, and more. Katana's 1 billion KAT campaign is live. Bridge and deposit directly into Vault in one simple click and start earning immediately on your Ether, Bitcoin, USDC, and more. Follow the link in today's show notes to get started. IEG layer is ushering in crypto's cloud era with the launch of IGEN cloud. IEG cloud is a full developer platform that gives developers cloudgrade programmability with cryptograde verifiability on any chain. INECloud's use cases don't stop at crypto. AI's rapid growth is reshaping how we live, work, and connect, which has simultaneously made it today's most

important and least trustworthy technology. IEN Cloud has arrived just in time to enable verifiable AI infrastructure with cryptoeconomic guarantees where incorrect behavior gets financially slashed. This isn't about picking winning apps or chains. With IGEN, stakers can own the fundamental building blocks of the verifiable cloud. Every application built on IGEN cloud draw security from staked IGEN tokens. Every cryptoeconomic guarantee is backstopped by slashable staked IEN. To learn more about how the IGEN token is securing a new class of verifiable apps and how to get exposure to this growing class of crypto infrastructure, follow them on X at IGEN layer. As always, investments in blockchain technology involve risk terms and conditions apply.

Do your own research. >> If I'm going to simplify a little bit, uh if I if I think about my dollar forecasting framework, uh there's sort of two main variables that we have historically put the most weight on. One is a global growth variable. It tends to be the case that when global growth is strong, the dollar is not doing too well. When global growth is weak, that the dollar tends to do very well. So that's a variable that historically has been very important. Arguably been the most important variable for dollar cycles, right?

Second variable everybody knows about is sort of the Fed variable, right? Okay. If Fed gets very doubbish, it impacts the dollar. We saw that in September last year, right? when they cut 50 basis points, the dollar had a move uh based on that. Right? So what's different about 2025 is that we have this kind of structural asset allocation theme and I think it's really interesting how persistent that theme has been in the last five months, right? It doesn't follow the cycles of the other assets. It's an independent factor. Uh I think uh we can say without blinking that we've been doing a pretty good job of embedding that factor in our dollar forecast uh for many months now since March at least and we will continue to

do so. Right? But how much weight do we put on that? Given that a number of players have already moved, we probably have to put a little bit less weight on that now compared to how much weight we were put in April. So it doesn't mean that the factor has gone away or it's reversed and positioning is a very tricky thing right so it might be enormous in hedge funds it might be very big in CTA space right but there other spaces where they've not moved yet so position is kind of really tricky thing but um I think it's a still a dollar negative but a less dollar negative than was a couple of months ago right so it is very important what happens with the cyclical signals so

we have a very interesting ing situation here where uh the September meeting is kind of like crunch time for the Fed. The Fed will have to make a stand. Are they going to continue to worry about realized inflation uh terrorists feeding into prices for a couple months or they're going to say consumption is really looking soft in the US economy. The US economy is eventually so driven by consumption that we have to respond to that. September meeting is close to 50/50 priced, right?

So, if you get that right, you're probably going to have a good chance of of getting the next couple of months of of dollar trading right because I think the cyclical dimension is going to be more important now than it was. But don't forget the first dimension, which is the global growth. And this is kind of what we're starting to see very recently, right? that there's actually some patterns in the market that smells like uh investors are getting more optimistic about global growth. Right?

So we we've had lots of concerns about oh Europe is going to be horrible. It's going to be a multi-year recession. They can't handle the trade tension with United States. They have structural issues and so forth. And guess what? The PMIs are already bouncing. Guess what? the ECB is going on a break. They're stopping the the cutting cycle, right? So even in China, I would say the the the cycle is actually looking like it it's turning better. So the global growth dimension is actually getting interesting.

You could have a situation where even if the sort of asset allocation factor has had the most juice in April and May and now it's it it's there but not as forceful but you can have a big dollar move if you have a combination of the global growth dynamic looks a little bit better and the Fed cutting like quite quite a divergence in signals. So, there's a lot of moving parts in the dollar outlook and I think from a trend basis uh the dollar uh still in a medium-term sense looks like we have downside skew. Um and I would say that even if it's true that there's some of

these tactical positioning metrics that looks like people are very on board with the dollar trade, but when you've had a 10-year trend, I think it's one of those situations. Do you focus on the tactical positioning or do you say there's some kind of structural position that's going to take a lot longer to unwind itself? And I think our framework is one where uh we do put more emphasis on these structural shifts than we would normally do. Normally we say we have to respect the tactical signals, but I think there's a more complicated situation at play here.

>> Okay. It feels like one of the main tailor risks associated with losing Fed independence is this unanchoring of inflation expectations. And I think that's a good segue into some of these charts that you sent over looking at what's been going on in in the break evens market. And I'll just pull them up. But obviously, yeah, like the last thing you want from losing Fed independence and control of monetary polic independence of monetary policy is this unanchoring of inflation expectations. So you have these charts here where you're just comparing five-year break evens um as as juxtaposed to oil. So just love to hear about yeah walk me through these what you're thinking about and what you're seeing here.

>> Yeah. So this is uh just showing some changes over the last year. So not the level of break even but how they changed right. So you can see uh when when Trump was elected there was uh optimism about what was going on the economy some concern as well about it being inflationary. So at the beginning of the year we had higher inflation expectations, right? And then we we stabilized in April as there was a lot of concern about growth being uh like a problem and um then you can see the blue line is sort of like what would be the impulse from oil specifically. You can see there was that spike in June when we had the Iran tension and that has then come out. So really the I think the main

point from this chart is the last couple of weeks right where the break even inflation is going up again there's nothing new going on in oil if anything the oil price signal is going in the other direction right so what is happening here in the last couple of weeks is the Fed independence effect right it is showing up in uh these break even signals and um I'm showing here the five-year right so um the the timing for me is is the tricky thing, right? Because on the one hand, it's tempting to say, okay, we have this incredible pressure on the Fed now, right? We're going to have more inflation in in the next year or two as a function of the Fed

overdoing it. But what's the Fed actually going to do? Right? Powell is still there. It's not so easy to get rid of Powell. Uh legal action takes a long time. Uh I don't think he wants to resign. uh the new appointment uh is towards the middle of next year, right? Coming into place and u also the the committee has 12 voting members, right? So even if you have one new appointment in in January and a new chair in the middle of next year, if if there was a very political appointment, I think the other parts of the FOMC

would pretty forcefully try to kind of push back against it. So I think the bottom line is it's not so easy to conclude that Fed policy is going to be dramatically impacted here in the next couple of months, next couple of quarters. So for me, it's more about over time, how's the Fed going to be, you know, influenced, politicized, but Trump only has two appointments to the Fed boy board in his entire second term, right? So it's pretty hard to think about the timing over which this would really be an issue. Right? So in a way in a way it's sort of a longer term issue. The fact that we have opened up

this can of worms. We don't know whether this political pressure is going to go away. Maybe over the next 5 to 10 years is going to be a big issue. So I actually think the market is potentially uh you know overdoing it in the very short end and not doing it enough in the long end. So I would argue that that should be sort of a steepening of of the break even curve which is which is not what >> yeah you have the tenure here as well and you can see there's there's some breaking out higher but you you don't think it's enough on the 10ear basis >> like you can kind of look at this 10 year break even right so this is um showing I guess uh five six years of history right and we haven't really broken out uh so obviously the spikes we

had in 22 was function realized being inflation being a got higher and that mapped into the forward-looking expectations. But uh even if we compare all the way back to 2007208 last time we had like a a boom cycle uh the current level of break even is not that high. So if there are real issues with you know fiscal dominance, debt levels getting too high, Fed independence being in question, I can imagine a situation where the longer end uh would move more. So we we'll think about whe there's some opportunities there. I think the opportunity is more in the long end than the short end. Like it's always complicated, right? We have a big AI theme going on in the background that is really from a from a

a pure macro perspective like a a deflationary impulse. So uh maybe the market is is trying to sort of balance those two things. If it was just a Fed independence issues, I think I think we should be moving more. >> Yeah. to Yeah, let's get into that a little bit and it's its reflection in in the long bond because it's to your point it feels like, you know, we've been basically ranging in it for for the past I don't know year and a half or so and it feels like we get to these very emotional extremes on on both ends and it feels like it's trying to balance it out. Um earlier in the conversation you you did mention that you felt like long bond yields are are relatively high and I'm just curious yeah how do you think about the long bond at this stage and

especially when you think about okay the last time that the Fed cut meaningfully last fall and they they cut 50 bips the long and sold off pretty significantly would you expect that situation again or was that because we had that labor market scare last fall that led to this long bond bid um there's like this maybe soft recession pricing in the long end um if we were to start cutting meaningfully here, what would you expect to happen on that long end? >> Well, so I think there's a there's a there's there's sort of two things to to really embed in your analysis here. So the first thing is what's happening globally, right? So global long ends are doing doing something new, right? So Japanese long end is is going up in a in a very dramatic fashion. U we have a lot of

issuance in Germany, right? So we're we're sort of flipping the situation in Europe from having the the safest assets being extremely scarce uh actually being quite abundant. Now that's going to put upward pressure on those yields. uh we have places like the UK where they have like pretty serious fiscal issues also putting upward pressure on long end yields right so the global factor is totally different from what we used to see right so we need to have a different uh framework for that so that's something that's going to keep the the long end elevated right and then there's the fiscal dimension we don't really have any signal that there's going to be a ser serious effort to bring down fiscal effort

deficits. Uh we but the only thing that's really positive on that front is the tariff revenue which is going to be significant. But we also have uh tax cuts that are really coming into effect in 26 that's going to push the deficit higher again. And uh from a political perspective, we even have um talk now about new tax cuts um that outside the budget, right? So another round of tax cuts being discussed, right? So we don't have a political situation where budget consolidation is really something that is a path we're on. It's not something that's being actively discussed. uh yeah

it's it's being discussed as more on a sort of fantasy as opposed to something that the policy is being uh uh targeted towards. So from that perspective I think and given also the the the correlation kind of shock we had in April it's hard to imagine that the long end is going to be rallying super hard. uh but um obviously if the short end moves a lot uh long end can move down as well but I think a lot of people are looking at steepening um trends in the yield curve and I think there's a lot of good reasons for those to to continue to play out. Uh but I think in the short term really the big question is whether the Fed is gonna start to shift its framework again from being very focused

on the realized inflation effects of uh the tariff to saying okay we have to look through them. I guess there's two FMC members who were already kind of moved to that camp. Uh but >> Bowman and Waller is that? >> Yeah. Yeah. So we've we have an interesting situation, right, where you have the chairman speaking in a certain way and um like I'm I'm generally not overly critical of Powell, but Powell is in a tricky spot, right? Because all the political pressure uh makes it hard for him to to react too quickly, right? He wants to be seen as reacting to firm evidence that the economy needs cut as opposed to giving

in to the pressure that is uh in the media picture every single day. Uh so you can have an ironic situation where all the name calling and pal is late um kind of um narrative actually makes him late itself uh because he can't be seen to give into it. But um I think we're going to have a real split at the FMC and uh that split might really play out and uh I would not be surprised if the vote in September is more split than we have seen perhaps for many years. One dynamic we haven't really talked about

in terms of trying to discern where the long end goes is just the dynamic between supply and demand. So on one side of that is trying to figure out okay who's who wants to be the marginal buyer of US long-term debt um at these levels and then on the other side of things is the issuance the supply side of things which is um you know in a couple next week we have the the next quarterly refunding announcement which will be a a pretty interesting one because of some of the commentary that's come in the last month and a half or so from from Besson and also from President Trump talking about trying to limit the amount of issuance of of of long-term debt at these levels and this theme over the that you know Janet Ellen started and Besson has continued of tilting more

issuance to bills. So I'm curious you could take one or the other there in terms of the supply versus the demand, but how are you thinking about just the state of of issuance of long-term debt when it feels like the only thing people really want to own are bills? >> The irony is that we we still have a fairly flat yield curve, right? Like we have short interest rates above 4%, right? And then we have a little bit of pickup further out, right? But you're not getting a lot of juice. So there's just not that much incentive to to get aggressive with duration, especially if you have doubts about whether the hedging property of the long end is going to work because it didn't work in in April. So um I think that means that a lot of players are more cautious. A

lot of international players are not as engaged in long as as they used to be. And uh I think the the Treasury is is aware of that and therefore the supply is going to be pretty cautious. Uh like when when Scott Besson was appointed uh as uh as Treasury Secretary, there's a lot of focus on the fact that he had been critiquing Janet Yellen for being too focused on short end issues, right? Uh but just because he's been critiquing Jan Yel doesn't mean he's going to go and and do the opposite of Janet Yellen, right? like some of that is also uh positioning yourself to to get the job which we can all understand is necessary in a political job. So um I think

they're going to be very cautious with their issuance and then really really it comes down to growth right if we have a real growth problem in the US economy then uh we're going to have you know deficit problems that are coming out of that. So, but we're really at a really at a at a a crucial time here, right? Because the tariffs are hitting and the real disposable income effect is going to be negative. We also have, you know, trade uncertainty that's negative.

H we have some tourism effects that are negative. Like there's all the fallouts from from the policies we've seen this year are kind of starting to really bite now. But at the same time, we have an AI effect that's amazing, right? We have an incredible capex uh push. Uh we're seeing anecdotes uh every week, right? This week it was uh X Grock and so forth where there's an incredible investment happening and uh the Trump administration is also trying to generate this big foreign direct investment inflow. We've been crunching all those numbers, right? the headline if you add up the headline announcements we've seen from the Middle East and

Japan and maybe there's going to be a Korea and an EU announcement but even if we add what we've had so far we're more than $3 trillion in kind of a I would call it soft soft foreign direct investment commitment but the numbers are very big uh even if we got you know half of that a third of that over some period of time it would be very big numbers so um there are some offsets to to these traditional cyclical drags and uh how that plays out I think in the next couple of months is is really important and um I would say from a rates trading perspective like what we have

recommended clients to do early in the year was to to do trades that said okay eventually the Fed will have to cut but they're not going to be able to go quickly right so we've seen that uh in the curve right where curve is still pricing a lot of cuts but they've been moved from the summer of 25 to essentially you know a lot of it is concentrated in the final quarter of this year and the first half right so that trade has played out right but I think now uh we're getting into a point where if the market uh prices out September more it can become a very interesting riskreward to say okay probably the Fed will get started around that point in time and rates are still pretty high right so if If if if the Fed

feels that uh there is a need to provide insurance for the labor market, right, we can certainly go uh meaningfully lower like I think it'll be relatively easy for them to do 100 basis points. And I think there's also kind of recency bias here that a lot of people are think just because interest rates have been around four or five% for a couple of years, it's hard to go much lower than that now. I don't think that's how the Fed thinks about I think the Fed thinks, okay, uh, if the if the labor market needs help, it will continue to provide more and more help, right? And that's how you get free cuts first, you get another one, and you can you can certainly get to more than 100 basis points, especially because the tax cuts

in the budget bill are going to work with the lag, right? So, it's really going to be mostly from the summer of next year that those cash flows be relevant. So, we have a year here where we kind of have to survive without that help. And that's probably the window where the the Fed will will be likely pushed to to do something meaningful. But the question is whether they're gonna start in September. That's going to be a fun thing to try to trade. >> Yeah. Big time. Um yeah, I feel like one interesting characterization of what you mentioned around a productivity boom led by AI and technological innovation is just looking at we got some PMI data that came out today where the services PMI surprised to the upside pretty significantly, but the manufacturing side surprised at the downside. And of

course, you know, tariffs are only on on goods and the US is 80% service based. So I'm curious, are you sympathetic to the idea that perhaps the the tariff risk is overstated in terms of the negative growth impulse and that you know these these AI innovations and this the serviceled economy could just look past that. >> We've been through a roller coaster with these tariffs, right? So, so we did we've done a lot of work uh on um on tariffs for for more than a year, right? We prepared for the election. We thought, okay, where are the tariffs going to end up? We have this tariff um forecast table which we kind of view as

a steady state of where the tariffs are going to end up, right? And the irony is that we're now gravitating towards a situation that is pretty close to what we thought was going to be the likely destination early this year, but we've had this huge roller coaster in between. And I think that is directly a function of a fairly chaotic way of making decisions, right? That we got to we got to more 100% tariffs on China kind of by accident. It was not something that was planned for.

It was like tit for tat escalation for a couple weeks and we had unworkable tariff situation. H but now actually with with the latest signals we're getting where Japan is at 15%. UK is in that neighborhood. Maybe the EU based on the the the reporting we've seen from the FT and so forth this week would also be aiming for 15. that actually is in line with almost like the academic literature. What's the optimal tariff rate? Optimal tariff rate is if you have a relatively uniform tariff on everybody. So you can't have too much circumvention of it and it's not so big that it really distorts the the flows that much and it can generate some

tariff revenue. So from that perspective, we've been through this crazy period, but maybe we're going to end up with a tariff regime that doesn't change the trade flows that much. to generate some revenue. uh over time the uncertainty will go down and uh still going to be a drag on disposable incomes of the people who have to pay it right but it's not like uh a a shock that is dominating everything like it's just a shock we have to take into account uh so from that perspective if that is where we're ending up I think the the market is adapting to it maybe not fully embedding the the the real disposable

income come effect, but I don't think it's going to be a shock that is going to be driving the market like we saw in April. That was a unique situation. It had to do with the the fear of sudden stops and trade flows and that's not where we are now. If we have tariff rates on all the big trading partners that are 15% EU and Japan, less than that for Mexico and Canada, trade flows are still going to be there. uh economies can do crossber business and it would be more like a cyclical drag from just consumers having to pay a bit more and that's very different from you know disrupted supply chains.

>> Nice. Yeah, I agree with that. I think that's a very balanced and pragmatic view of something that just feels like a roller coaster because it has been. Um looks really great to have you on the show. Really enjoyed that. Where can folks go if they want to see more of your work? >> You can go and check out what we do at exanted.com. Um, if you want to do look at some of the the the content we have in public domain, uh, I have a a Twitter handle that's Jay Nordvvic, but we also have a Substack where you can look at, uh, some of the snippets of what we do. Uh, that would not be the most trading related research we do be more macro research or sort of big picture capital flow analysis. So that substack is called uh, insight uh, money inside and out. So,

money inside and out is the substack and um that's a good way to to get a sense of of uh what we do. >> Amazing. Well, I really appreciate you joining. I I enjoyed that a lot. Appreciate. >> Thank you very much. Thank you.