Transcription
There's a new chairman of the Federal Reserve. Jerome Powell is out and this guy Kevin Worsh is in. And the new Fed chair just changed everything. I'm going to explain exactly why this is such a big deal and other reasons why it might not be that big of a deal in three simple fast steps.
Step number one, let's go over how everybody, including Donald Trump, thought that this guy would be very dovish, meaning he wants to lower interest rates. But based on what we heard from his press conference, he's the opposite. He's like Paul Vulkar. He's even more hawkish than Jerome Powell was. So, this caught the market way off sides, especially the bond market.
Which takes me to the first chart of the day, the 2-year Treasury yield. Now, today is Thursday, but let's go back to well, actually, let's go all the way back to last Friday, so you guys can get some context here as to what's going on and why this is such a huge move. On the left, we go from 4% up to 4.2%. Now, later on in the video, we're going to talk about the relationship to the two-year Treasury and the 10-year Treasury, the yield curve, and why Kevin Walsh has dramatically impacted that yield curve, and what it tells us about the future for the housing market, the stock market, and the US economy.
But let's get back to this chart here. Okay, Friday, we're last Friday, we're right around 4.1%. We kind of go down here. We probably got some news that was a little disinflationary, let's say. And then we kind of trend, you know, back and forth, back and forth. And then boom, we come out with the rate decision, which by the way, they didn't increase interest rates. They kept them the same. But when Walsh came out and started talking about all his task forces, we'll get into that in a moment, the market interpreted that as very hawkish. So, the odds of the Fed actually raising interest rates increased. This is why you see this huge move in the two-year Treasury going straight from, let's just call it, right around 4.08 up to 4.22. 22 is I think where it topped out for the day.
Now, you may say to yourself, "Okay, George, you're zooming in on this chart. It's not that big of a deal." It actually is. And the 2-year Treasury to have a move of 10, 12, 15 basis points in the matter of five minutes. That's something that we have to pay attention to.
But before we go any further, we have to talk about the press conference where Kevin Walsh is saying he is going to change everything about the Fed and he's going to do it with these task forces just like Obama. Remember Obama? I think he was the first one that came out with a task force for this and a task force for that. For you watching this video right now who are old enough to remember Obama and all the task forces, do you remember those task forces doing anything? Neither do I. But more on that in just a moment.
But it doesn't curb his enthusiasm. So the first well these are all the task forces that he's going to implement but the first one I think is really the key to focus on he's going to implement a task force for communication. I think we read about that in a book by George Orwell. What was that? Ah yes 1984. It was called the ministry of truth. So that's fantastic that Kevin Walsh wants to basically set up a ministry of truth for the Federal Reserve. But I can see why because the Fed is full of this BS. And that's pretty much the only thing they can do is try to manipulate you into doing what they want you to do through psychological operations. SCOPs in other words.
But this takes us to the second task force which is the balance sheet or BS whichever you prefer. So the task force for BS is number two. Number three we have a task force for data sources. Now I'm not sure exactly what that means and how they're going to source data from other areas but okay. We'll give him a thumbs up for that.
Now, this one is straight up lol. Why do I say that? Because number four is a task force for productivity and jobs. As if the Federal Reserve has any control over the entrepreneurs in the real economy that are actually the job creators actually hiring and firing employees. But where this gets really, really, really, really, really lol is the fact that they're focusing on productivity.
Now, let's just step back for a moment and let's think about what the Fed actually is. So, the Fed, as you know, is comprised of over 900 PhDs. 900 PhDs at the Fed. And what are they tasked with doing? What is their task? Well, their task is to figure out communication. Their task is to figure out the balance sheet, data sources, the labor market, and oh yes, inflation. So, you already have a giant task force. All you're doing is layering a task force over an existing ginormous task force that can't even do their tasks correctly and then you're calling it the focus productivity. Well, I think Kevin Worsh needs to focus on the productivity of the Federal Reserve and his 900 PhDs, not necessarily the productivity of the US economy.
And then the fifth one, as we said, is all about inflation. They're going to get hyperfocused on that as if they were just kind of ignoring it in the past. But maybe they were, because let's remember, the Fed hasn't hit their 2% target in five years. And if we want to go all the way back to the GFC, we could argue the Fed hasn't hit their target in 15 16 years. Why? Because remember going back to the good old days of quantitative easing one they were trying to get the inflation rate up to their 2% and they never could until they got the surveys sickness. So maybe for one week during 2020 they hit their 2% target but for the prior 10 years let's say they couldn't hit their target. They're way below and then for that one week during the surveys of sickness they hit it but that was on its way up to 9.1%. We're talking about inflation and then it's been above the target for five years.
But we all know the definition of insanity. It's doing the same thing over and over and over again and expecting different results. Well, what is this guy doing? He's taking 900 PhDs and just adding another 900 PhDs to these PhDs that were miserable failures and somehow trying to make you believe that he's going to get different results. It's all a ruse. It's all a scop to manipulate you. But unfortunately, the markets actually pay attention to this stuff. So, we have to pay attention to this nonsense to set up our portfolio in a way that has the highest probability of making a return.
Step number two, now to determine if these big changes that Kevin Worsh is making is actually going to make a difference, we have to step back and ask ourselves or remind ourselves what the Fed actually does. What can they do? and what can they not do?
So, let's start off by understanding what they actually can do. Because if you listen to Kevin Walsh or Jerome Pal or the mainstream media, they would lead you to believe that the Federal Reserve can do anything they want, like they're omnipotent, that they can just sit there and just wave a magic wand and something magically happens that they want to happen. But in reality, that's not true. That's just the way they use the SCOPS we were talking about before.
So first and foremost, what they do control is the Fed funds rate. So you can see that right here in this chart. So we have to ask the question, is this rate that the Federal Reserve is setting that much different than the overnight rate that the market would actually set? It's a very valid question because if the answer is no, then that whole big building with their 900 and now 1,800 PhDs or however many PhDs they hired due to these task forces if they're even necessary, if they even matter at all, or they're just trying to convince you they matter.
Now, let's move on to the second thing they actually can do, and that is the BS, the balance sheet. But I want you to focus not necessarily on postGFC where we had QE1, QE2, QE3, QE4, QE infinity, QT, and then just adding a few bank reserves here and taking away some bank reserves there. I want you to focus on what happened before then. You see this line? Pretty darn straight, isn't it? So, we can go all the way back to the late 1950s. And you can see the amount of bank reserves that the Fed actually can control really didn't change. So let's just say from 1960 to 2007 that's 47 years the amount of bank reserves didn't really change. So what this tells you is the system the monetary system really doesn't need bank reserves. And if they do need bank reserves, they sure as hell don't need $3 trillion worth of bank reserves when you barely add any 40 billion with a B in January of 2007.
So the analogy I like to use is assume you've got a diesel truck or let's assume all the cars on the road are diesel or electric. That's maybe a better example. And let's say the Fed increases or decreases the amount of gasoline. Well, how would that impact the overall economy if every single person drove a Tesla? The answer is it wouldn't. And it's the exact same thing with bank reserves. Can they manage the number? Can they increase it and decrease it? Yes. Does it matter? I doubt it.
So if we can determine with a high level of confidence that their balance sheet BS management really doesn't impact the monetary system other than just through psychology. It takes us back to that interest rate question you know at the front end of the curve the overnight rate or interest on reserves IR whatever you want to call it.
So, now what I want to do is pull up a chart of the Fed funds rate versus the 10-year Treasury because you guys know from watching my videos that the 10-year Treasury is really all about the marketplace. The Fed isn't manipulating that number. It's all about what the market thinks the future looks like for growth and inflation. We call it growth and inflation expectations. So, we'll assume right now the 10-year Treasury yield for the most part is being set by the marketplace itself.
Okay, let's look at this chart going all the way back to 1962. In 1962, we can see the delta between the overnight rate and the 10-year Treasury was right around 1.25% or 125 basis points. Now we fast forward to where we are today and we're right around 80 basis points. And then if you just kind of eyeball this, you can see that the average if we go all the way back to the early 1960s is probably right around 100 basis points. And just as a reminder to make sure we're all on the same page, currently we're right around 80 basis points. So should the Fed funds rate be different right now? Maybe, but maybe by 25 basis points. And at the end of the day, you got to ask the question, does that really matter?
So the main takeaway is the Fed really only has two tools. and the balance sheet, we can determine with a high degree of probability that it really doesn't matter in anything other than psychology. And with the overnight Fed funds rate, it seems they're just following the market. What this is like, it's just like if I go outside right now and come back in and tell you, oh my gosh, you would not believe how cold it is. Did I just control the weather? Is the weather cold because I came in and said that it was cold or is this just a reflection? Is my response a reflection to how the weather actually is regardless of what George Gam is doing? We all know the answer, but it's the exact same thing with the Federal Reserve and interest rates. Do they really control the interest rate? No, not in my view. Just like I didn't control the weather, the interest rate they set is merely a reflection of where interest rates likely would have been regardless.
Now, can they get it wrong? Can they be wildly off up and down? Yes, for the most part. Are they off by that much? Are they off by more than 25 50 basis points? Probably not. And you guys know just by having common sense that whether the Fed funds rate is at 3.5 or 3.75, it really doesn't have that big of an impact on the overall economy.
So now you see why I said in step number one, the key here is the task force that's set up for communication or the Ministry of Truth as I like to refer to them. This is really the crucial component of what Kevin Walsh is doing because that at the end of the day is really the power of the Federal Reserve. It's not with interest rates. It's not with their balance sheet. It's with their psychological operations to try to manipulate you in doing what they want you to do.
Step number three. Now, let's go over what the yield curve, the marketplace, is telling us about the new Fed chair and how that could impact your portfolio and impact the overall economy.
So, what we have to do is we have to start off by looking at what has happened since Kevin Worsh came out and made those announcements during the press conference when he went from being or expected to be very dovish to very hawkish like we said in step number one. Well, since we just started recording, the 2-year Treasury yield has come down dramatically. Remember I said it went way up to call it 4.22%. Now it's all the way down to 4.17% roughly down five basis points. So this is telling us that that initial reaction from Kevin Worsh that he was going to be hawkish in reality probably isn't correct.
Here's what I mean. But editor go ahead and throw up the yield curve a chart of the twos and the tens. Before we looked at Fed funds and the 10-year Treasury. Now, let's look at the 2-year Treasury relative to the 10-year Treasury yield. This is really the key. And we can see it's right around 30 basis points, which relatively speaking is very low, usually right around 100, maybe even 150 basis points.
So, let's think about what's happening right here. You've got the 10-year Treasury yield right around here. And then you have the two-year Treasury yield gradually going up with the exception today, this trend going higher and higher and higher because the Fed is being perceived as more and more and more hawkish. But what is the 10-year Treasury telling you by not moving as much as the 2-year? Therefore, the curve flattening out, it's telling you the Fed is wrong. even their predictions or their expectations are wrong.
So, just to make sure we're all on the same page, let's take all the the wonky stuff, yield curve, and distill it down to a level that everyone can understand. So, what the market is telling us right now is that Kevin Walsh can talk as hawkish as he wants, but his next move probably ain't going to be up with interest rates. it's most likely going to be down. So, he's going to go from a dove to a hawk and then straight back to a dove again, which would make a lot of sense because the fact that he's going to be proven wrong would be extremely consistent with what we saw from Ben Bernani, Janet Yellen, and Jerome Pal. Remember, inflation was supposed to be transitory.
So with your portfolio or with your analysis of the overall US economy, I would expect lower rates in the future, not higher rates. Now, a lot of you may be saying to yourself, well, that's great news. But then what you have to do is you have to realize what lower rates tells us about the overall economy. And that usually means the economy is getting worse. It's not getting better.
But just to make sure that all of us right now understand exactly what we should expect from the Federal Reserve, we're going to go over a quick equation here that I just came up with. So, I want you to answer this question for me. What is 0 plus 0? We don't have any Jeopardy music. Editor, throw in some Jeopardy music really quick. Well, we all know that's zero. So, if in the past the Fed or the you can call it the task force, I prefer the task fail and their 900 PhDs failed at every single prediction, meaning their accuracy was zero. If you add on another job of the hut task fail onto this one, their predictive powers are going to be zero. What should you expect from the new Fed on a move forward basis that they're going to be exactly as bad as all the other Fed shares we have had in the past. In other words, the more things change, unfortunately, the more they stay the same.