For those of you who would prefer to listen:
Quality meetings require proper preparation and participation. It fuels ideas and honest debate. Everyone contributes. It’s important to create an environment where people feel comfortable speaking their minds and are recognized for honesty and integrity. A little humility helps, too. Respect for different ways of thinking should be encouraged. Strategies also need to adapt and evolve. Conventional approaches to unconventional situations generally fail. Old ways can get stale.
The Fed had another meeting this week. This one was a standout of sorts because it was the first for the new Fed Chair. Kevin Warsh made it clear that this was a new Fed and new approaches were to be embraced, learning from the mistakes of the past. History will likely shine bright on Chair Jerome Powell. He navigated the uncharted territory of the pandemic and emphasized Fed independence and integrity. There were some clear mistakes. Most significant was waiting to raise rates as the inflationary pressures were first diagnosed as transitory. Acknowledging a mistake is the first and best step in solving problems. Powell showed humility and did just that.
One of the first things Warsh did when he took over the head of the Fed from Chair Powell was to establish task forces to reassess the central bank processes. He wanted to understand what was working and what was not. He wanted to hear what other members thought. Listening is a valuable tool in leadership and decision-making. He has been a big proponent of authenticity within America’s central bank. He wants honest dialogue. He describes these meetings as Family Fights. That’s an interesting approach.
As we all know, family fights differ from disagreements with co-workers or friends because they are rooted in history. You live together. You’re genetically tied together. You’re kin. The thing is, those arguments rarely stay focused on the issue at hand. They often stem from old grievances and past mistakes. What’s more, those fights and criticisms can get highly personal. They’re emotional. Things said can be brutal. But family members can usually get away with it. Sure, it takes a little time for the smoke to clear. But family fights generally resolve themselves in a better place because they’re authentic and founded in care. Of course, that’s not always the case. And if politics or adult beverages are added, then all bets are off.
It appears that Fed Chair Warsh wants to revert back to the Greenspan Fed approach. Fed policy was much more opaque back then. Greenspan seemingly went out of his way to confuse people while answering questions and providing updates. It got to the point where people would study his briefcase for insights. The thinking was, if it was thick that day, that meant a change in policy was coming. A thin briefcase meant no change. It wasn’t always accurate. But it definitely was a thing throughout the 1990’s and into the 21st century.
Increased transparency came in response to the Financial Crisis. It was warranted considering the financial and economic damage done. But there can be too much transparency. What’s more, it is abundantly clear that the Fed kept interest rates at the emergency level near zero for far too long after Covid. Cheap money fueled bubbles in asset prices and inflation. We are still dealing with these issues, which stem back to 2022. The new Fed seems to want the Market and investors to focus on real-time data and do its own thinking, relying less on what the Fed says. This from the Fed Chair: “Financial Market prices are probably the most important source of information to guide central bankers. I think the financial Markets work less efficiently when they ask a question, ‘How will the Federal Reserve react to that incoming information?”
The result at Fed Chair Warsh’s first meeting: No cut and no hike. There was no change in interest rates. But there was a big change in communication. The policy statement consisted of just 3 sentences with no forward guidance. It highlighted uncertainty in the Middle East, which is putting pressure on inflation. One thing was crystal clear: the focus is on price stability. The Fed seems to be comfortable with the Job Market. Inflation is what concerns it most. Persistently high prices have been a burden for the American people. Warsh mentioned advice he got from one of his mentors, George Shultz, best known as Secretary of State under President Reagan. Shultz told him that press conferences are useful. But only if you have something to say. Warsh is going to take that approach at the central bank.
Kevin Warsh has ties to both the East Coast and the West Coast. He is a Wall Street veteran and former Fed official who went to Stanford and is a fellow at the Hoover Institution. Warsh was first appointed to the Fed in 2006 by President George W. Bush. At age 35, he was the youngest to join. Kevin Warsh is married to Jane Lauder. Her grandmother was Estée Lauder, founder of the cosmetic company. Their family fights are likely a little different than ours.
Why does all this matter? Interest rates are the price of money. They determine the cost to borrow. Interest rates influence all things financial, from stocks and bonds to home prices and loans. For money, it’s a really big deal. The Federal Reserve oversees the front-end of the yield curve, managing the overnight rate. That’s the rate banks borrow from each other. The Market determines everything else. It represents the wisdom of crowds. The Bond Market is considered the smart money. It’s a powerful force. James Carville said it best: the Bond Market can intimidate anyone. He also said, “It’s the Economy, stupid”. In this election year, those words still ring true.
At 4.16%, 2-Year Treasury yields hit 16-month highs. What’s more, the spread between the 2-Year and 30-Year is just 84 basis points (0.84%). That is the tightest in over a year. The Yield Curve has been flattening. The average spread over the years has been closer to 1.5%. That’s the Market saying the next Fed move is likely a hike. But it’s also indicating with the Long-Bond that economic growth might be slowing. High inflation and slowing growth is a tough combo. AI is definitely carrying the economic load.
America’s Economy continues to chug along at a solid pace, despite the high prices. You know whose Economy is showing signs of sluggishness? China. Consumer spending in China declined last month for the first time in over 3 years. Exports have driven much of China’s economic growth. It’s created a global trade imbalance that is stirring up geopolitical tensions again. There’s a trade war brewing with Europe. Strong exports are offsetting the weak domestic demand. What’s more, China’s real estate market is now in its 5th year of correction. The number two Economy in the world is far from strong. The United States continues to outshine its rival.
BMW is a proxy for global economic activity. The German car company just lowered its outlook for the rest of the year, citing China and the conflict in Iran as the chief sources of weakness. Sales in China fell 18%. The reason is 2-fold: Softening consumer demand and fierce competition from Chinese manufacturers. With 1.4 Billion people and nearly 400 Million cars in circulation, China is by far the largest market for automobile sales. The Asian nation accounts for one-quarter of BMW’s annual sales. The thing is, it used to be one-third. China’s rapid rollout of electric vehicles has sent shockwaves through the industry. It’s sent pricing down, which is good for consumers, but unfair practices by the Chinese government makes things beyond difficult for global manufacturers. In case you’re wondering, just 17% of BMW sales come from the United States. No surprise, over 40% come from Europe, its home market.
The price of Oil has come down substantially. At $76 for WTI, it is trading at its lowest level since early March. It fell 13% in just four sessions. It’s down nearly 40% from its wartime peak. The deal reached between the US and Iran, reflected in the Memorandum of Understanding, is favorable to the Global Energy supply. It allows Iran to restart Oil exports immediately, while the US grants waivers on sanctions for 60 days. Iran could benefit by adding $60 Billion a year in Oil revenue with an additional 1 Million barrels per day above pre-conflict levels over 3 years if all the sanctions are lifted and stay that way. Oil flows through the Strait of Hormuz have already picked up, according to reports. Saudi cleared 3 supertankers through the Strait of Hormuz following the signing. That was the first Saudi-owned tankers to cross since the fighting began.
Expectations might be a little ahead of themselves when it comes to Oil flows. Goldman said capacity might only reach 70% of their pre-war level. It’s still a very risky environment. Shippers have indicated they are waiting on more clarity on mines. Some insurers and shipowners still want further assurances in order to restore traffic. What’s more, the agreement leaves open the possibility of Iran enforcing tolls after the 60-day period. That cannot be acceptable to the United States, nor its allies. These uncertainties will continue to weigh heavy on both the Market and the Fed. Lower energy prices are most welcome. They just can’t be counted on to last. At least not yet.
We’ll be watching, with interest, the developments of these “Family Fights” at the Fed. With honest dialogue and informed opinions, focusing on facts, the prospects could be quite strong for this new regime at America’s central bank. Disagreements are healthy. Debate is a good thing when done with respect. It can be even more effective when it happens behind closed doors. That leads to better decisions with better outcomes. Family matters can be complicated. Family is authentic. Family is like branches on a tree. Family is forever. The Godfather knew best: Never go against the family.
The Market is closed Friday, in observance of Juneteenth. Our offices will be closed too. Have a nice weekend. Happy Father’s Day to all you fellow dads! We’ll be back, dark and early on Monday.
Mike
