Danielle DiMartino Booth is a former advisor to the Federal Reserve Bank of Dallas and doesn’t hold back when it comes to discussing how her former central bank colleagues are doing. Today, she is the head of Quill Intelligence, the company she founded whose goal is to analyze the trends and provide critical analysis on what is driving the markets, both in the United States and globally. She joined the ETF Think Tank to discuss the Fed’s ability to navigate the current environment and more.
The first question was very straightforward – can the Fed create the future it wants? Booth doesn’t think so. She notes that the Treasury yield curve doesn’t lie and the fact that the curve collapsed and spreads narrowed considerably was telling. The markets are clearly concerned that the Fed is going to get too aggressive, the yield curve will invert, and the central bank will be forced to back off on its plans to tighten. She thinks the markets are freaked out because of balance sheet runoff going on in the background and that the Fed will be able to get off 2 quarter-point rate hikes max.
While we know that the Fed has bought hundreds of billions of dollars of Treasury securities, the question arose of whether or not the Fed is influencing the corporate and high yield bond markets. Booth says there is clearly the presumption that the Fed will backstop the credit markets and that could be part of the reason why credit spreads haven’t blown out. Investors are also going further out on the credit and illiquidity spectrum not knowing really what they’re buying. Spreads have gotten all the way down to 2007 lows and it was the biggest red flag ever. Junk is priced wildly incorrectly, and things could get really ugly.
Booth talked about the Q4 U.S. GDP report and said it’s much weaker than the headline number indicates. Inventories rose by more than 4% and that’s going to be deflationary to the economy. Growth forecasts could end up coming down closer to the 1-2% range. The strong inventory build could be an indication that supply chains are fixing themselves since companies are clearly getting the inputs necessary to build products. If that’s the case, inflation could come down even quicker and present another challenge for the Fed.
Other key takeaways:
- The Fed absolutely can’t raise rates into an inverted curve. It would effectively be acting against all of its mandates at once. With spreads shrinking, the markets are sniffing out a regime change. The idea of five rate hikes is ridiculous.
- Booth calls index rebalancing “mechanistic and extraordinarily active”. The more that markets fall, the more money that will be rebalanced back into the S&P 500, which is essentially just a dozen or so names. With so many workplace retirement plans default to target date funds for their employees, target date funds have the potential to turn into monsters.
- In the past, people were used to 10–12-year economic expansion cycles. Today, we don’t live in that world anymore. We moved quickly into the COVID recession, and we could be quickly moving into another recession. Treasury yield spreads used to have a gentle lag effect, but the fact that the 10Y/2Y moved from 78 bps to 62 bps in an afternoon shows that things are happening so fast and we’re not used to the speed. Stagflation is a massive threat.
- Could risk asset prices be positioned to rally heading into the midterm elections? Politicians bending towards the market is bullish, but you have to get past the point of bearish first. If the curve gets closer to inverting before the election – Booth says 15 basis points on the 10Y/2Y could be a level to watch – policy likely shifts to dovish and asset prices, including Bitcoin, could take off.
- Inventories building and initial jobless claims moving higher again suggests we are currently in an industrial recession. China’s stimulus will likely focus inward and the idea it will save the world’s industrial sector is false.
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