Federal Reserve Actions: Meeting Hysteria Needs to Change

Uncover the mysteries of the Federal Reserve's impact on our economy with Clem Miller and Steve as they navigate through the complexities of interest rates and quantitative easing. In this engaging talk, we dissect the Fed's dual mandate to spur employment and manage inflation, revealing how its extensive access to data can outpace even the shrewdest of market forecasters. We tackle the delicate balance of transparency versus action within the Fed and weigh in on the ethical quandaries that surfaced during the COVID crisis. By tuning in, you'll gain an enriched understanding of the nuanced relationship between the Fed's policies and the ever-evolving economic landscape.

When it comes to your wallet, staying informed is key. That's why in our conversation, we also scrutinize current investment strategies, debating the allure of bonds and equities amidst today's interest rate climate. While I, your host, argue the merits of liquidity over fixed income, Steve offers a counterpoint with the potential security of corporate bonds. We agree that investment choices should be driven by personal asset allocation, regardless of the Fed's latest moves. Join us for a thought-provoking exchange that will leave you with valuable insights for navigating your investment journey with finesse and confidence.

Straight Talk for All - Nonsense for None


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Transcript

Clem Miller: 0:24

Sceptics guide to investing. I'm Clem Miller and today we're going to talk about Federal Reserve meetings and soothsayers. Steve and I will dig into the recent meetings and how they might affect markets. When the Fed meets, which is really about 10 times a year, they're trying to satisfy their dual mandate. So what is this dual mandate? It's this mysterious full employment, however they might define it, and inflation control, which they've said is roughly keeping inflation to roughly around 2% per year. They use the interest rate level and quantitative easing and other tactics to help the economy achieve what they define as success. There's always one element which is always present, which is prognostication. Everyone likes to play predict what's next. So, Steve, do you lose sleep during the week of Fed meetings? No, and why is that, Steve? Fed?

Steve Davenport: 1:30

Meetings are a way to fill time on finance TV between crypto and meme stocks, no really. The Fed plays an important role in the markets. It's just unlikely that the prognosticators could be weighing anywhere near the data provided by the Federal Reserve system. There are 12 regional banks, each staff with economists and professionals to evaluate how the local economy is doing. Five of the regional bank presidents joined the Board of Governor numbers in a rotating basis. The system of regional banks was designed to represent the uniqueness of the different areas. The New York Fed has a much different business mix than the Dallas Fed. They are using the latest government data and they have use of any international economic research to inform their decisions.

Steve Davenport: 2:23

I have a hard time thinking that some of the reporters or strategists have anywhere near the information to evaluate and make a completely informed decision. I'm reminded about the Teddy Roosevelt quote about the arena. "It is not the critic who counts. Credit belongs to the man in the arena. If he fails, at least he fails while daring greatly, so that his place shall never be with those among the timid and cold souls who know neither victory nor defeat.

Clem Miller: 2:57

That's quite a quote, Steve.

Steve Davenport: 3:01

Yeah, it might be too much for the Fed, but I believe that people in the room are making the decisions and people outside the room can't really say whether it's good or bad .

Clem Miller: 3:13

So really, does the Fed really get the job done in terms of helping the economy?

Steve Davenport: 3:20

I think it's interesting how, even though the Fed sets these rates, the market will also tell you from the prices on some of the futures that they disagree. So I think that there is a constant battle between the market and the Fed. One future prices for different time periods in the market vary from what the Fed thinks the rate should be. Fed works on a basket of common goods which may not be the retiree or younger person's actual expenses. So when they say they got it to 2%, that's 2% for a certain group of the economy. The Fed has a new goal, number three, of transparency, and it's very hard when they don't have great models or a track record. These goals of transparency sometimes become just as obfuscating as the prognosticators.

Steve Davenport: 4:20

And last item is interest. Rates are a very blunt tool and everybody likes simple answers. So when we say the Fed's increasing rates or decreasing rates, it gives somebody an idea that more liquidity helps the economy. Less liquidity slows the economy down. It's really a lot more complicated than that, but that's what people like to believe. So US regulators and the Fed have struggled. When inflation matters and when it will be sticky, we value certainty and markets are forever reminding us that the more things change, the harder predicting becomes.

Clem Miller: 5:02

Yes, but still you got all these folks on television opining about the Fed and it really makes for a lot of sometimes interesting and sometimes boring television. So what frustrates you really with the Fed hysteria?

Steve Davenport: 5:19

Well, I'm a quantitative guy and I believe that you got a measure. If you say that you did predict something, how would your prediction be measured? You know how did it come out? There are no metrics on any of prognosticat ors. They all claim authority, but they haven't shown any familiarity with the measurement concept. When there is a surprise, all previous guarantees are suddenly forgotten. Prediction is hard. These people want to be able to make the claims of expertise when I think knowledge is what they should be providing. The Fed acts in this case. For this reason, At this point of the interest cycle, the market response is positive because lower rates indicate a better operating environment for business. That's what I'd like them to be saying. I think. When they say the Fed is loose, Fed is easy, Fed is guaranteeing markets good returns, those are all pretty bombastic statements that I think could all use a little bit more refining. I'd just like them to talk to us like adults and not try to treat us with one word or eight second blurbs.

Clem Miller: 6:34

Unfortunately, you need some degree of market expertise to be able to interpret this. You have a lot of folks on TV who are thinking about this from the perspective of being TV stars more than anything else. Steve, the task is hard, but we do have to admit that the Fed has a lot of resources to fix things. They have hundreds of economists working for them. They should be able to have some success in being able to control inflation, keep the economy going Sure. The results so far have been pretty good, but in past years, past decades, they haven't been so good. The task is hard. What do you think about their ability to actually achieve success in fulfilling their mandates?

Steve Davenport: 7:35

Yes, I think they have a lot of resources, but one incident that really sticks in my craw was during COVID. We saw the underside of the Fed. Three governors engaged in large personal trades while they were in the process of deciding how to react to the COVID crisis. As a professional, our firms and our industry certification, for example, the CFA, require a basic level of ethics. At various banks, I was not allowed to take anything beyond a glass of water when attending industry events. There can be no signs that what you are doing performing in the best interest of clients. Trading is pre-approved and controls are significant.

Steve Davenport: 8:25

The Fed governors argue that there was no system, so they didn't do anything wrong. There was nothing illegal the term is front-running and they had significant information advantage. By information advantage, they were the ones making the decisions. All three decided to resign in retire versus go through a review of the trades. We've seen a similar situation with Clarence Thomas and his vacation with billionaires. We've seen House members and senators trading and having an unusual amount of success with companies who happen to be in front of them on their committees. So these are complicated to control, but these are common sense. What do you think about this, Clem?

Clem Miller: 9:21

So first of all, Steve, I'm very surprised that you were only allowed to take a glass of water. At least they should have allowed you to take a donut or a cup of coffee or something. Really beyond that, I agree with you that it's really common sense to avoid conflicts of interest. It's so important to put rules around conflicts of interest to try to avoid that. In the industry, we not only have regulations that are imposed on us, but we have ethical obligations through our CFA and others through their CFP program and so on. The whole idea behind this is that we're interested in promoting the welfare of our clients, of our customers, and not our own personal interests.

Steve Davenport: 10:28

For example, glenn, I used to have to report my son's college account and when I were, I traded. I mean I had $4,000 or $5,000 in the account and the trades were usually $1,000 or $2,000. You have Fed governors trading millions of dollars a day or two before their meeting announcement. I don't think this is accidental. I don't think it's small and insignificant.

Clem Miller: 10:58

Therefore, if it has size and it has obviously an influence on how much you trust these people and I think trust matters Yeah- I mean just I know that there have been mutual funds or ETFs that have been created around the idea that you invest with where Congress is investing their money, right where Congress people are investing their money, or against where Congress people are investing their money. I mean it could go either way. Congress could be. You could assume that Congress is doing the right thing by markets and invest where they're investing, what the stocks and industries where they're investing, or you could make the alternative assumption that they don't really know what they're doing. I don't know how the market or me as an investor can use information about where policymakers are going with their own trades. I just don't want them to make their own trades in connection with policymaking.

Steve Davenport: 12:08

Yeah, I think as a CFA, we have a code of ethics and we're trying to perform for the best interest of our clients. If I look at congressmen, I think they should be trying to make the best what's in the best interest of their constituency, not in the best interest of their brokerage account. That doesn't seem like a lot to ask, that's right.

Clem Miller: 12:33

Obviously, you're skeptical about the Fed, as am I question is whether our skepticism really turns into cynicism. What do you think, Steve?

Steve Davenport: 12:49

I'd just like to finish with a very simple concept Ethics and leadership need to be more automatic versus reactionary. I don't think the Fed should have to figure out, or the Supreme Court should have to figure out, that there's a potential for a conflict of interest and they need to observe some rules. They should be following the law as a very minimum bar, not all you need to satisfy. I think you need to believe, everyone is watching. The three governors quietly left the institution, but the institution has suffered some lack of trust. Trust loss can take a lot longer to regain. All Congress and government employees with non-public information need to behave better. Period Drop mic, as we have seen with the Binance and FTX. Fines matter. The lack of a clear instruction on trading should not mean there are no rules. There needs to be a basic level of responsibility which comes with a greater power and authority. Yes, regarding this situation, I am cynical that there is not greater outcry or a desire to improve.

Clem Miller: 14:29

So, Steve, what do you think about the direction of Fed rate policy, to the extent we can even know that, and does that environment create opportunity in certain asset classes?

Steve Davenport: 14:46

Yes, Clem, I believe that we can talk about direction and we can talk about generally tightness or looseness. I don't want to be the one that says there is going to be 50 basis point of cuts or 75 basis point of cuts. I think that presumes a greater degree of skill and knowledge. I think we are going to be higher for longer because I think that rents and some of the inflation is going to be a little stickier. I think that inflation is a slippery snake to tame. Savings levels, delinquency on cards and higher rents will continue to challenge consumers. So I believe that the rates will probably stay a little higher longer and I think the market will react in somewhat of a negative manner.

Clem Miller: 15:38

So, Steve, in some future episodes we are going to be talking about the election year, obviously, but at this point, do you see anything happening this year that would affect the Fed?

Steve Davenport: 15:53

I really don't. I think that the Fed will try to step aside, as they always have, and try to be apolitical. I think that's like trying to ask a person to be without sin. It's not really possible. I think that people are naturally going to do things that are in their best interest, and if it means the Fed Powell doesn't want to do something because he's coming up for reappointment, unfortunately, I think that they're all appointed with the idea that they don't react and they are not influenced politics. So I believe that there's probably a pretty big instinct on their part. If they're going to cut, they'll cut once or twice in the beginning, in March and April, and then, once the economy gets hot and heavy with the conventions in June, I think that we will see them go to sleep for a little while and then wake up in December again with potentially cuts when the election's over.

Steve Davenport: 16:59

I think the bond environment currently creates an opportunity. Bonds are better right now, with the rates probably at their peak. Stocks have done well. Same taxes is usually a good thing, my father, the CPA, used to say, because it means you're making money. I think it's a good opportunity for people to stabilize on a certain percentage in their asset allocation and we'll see what happens. I think that there's a chance that the equity market will correct a bit and there's a chance that bonds will stay strong and represent a more reasonable part of your allocation than it did when rates were zero.

Clem Miller: 17:40

So, Steve, we got a question in our mailbag what investment opportunities do you to see in fixed income? And let me answer that first and then I'll turn it over to you. So you know, right now, as it stands, I don't have any fixed income in the portfolio. I do have cash in the portfolio, but no fixed income. I'm not 100% convinced that long-term rates, long-term yields, are going to come down fast, even with the Fed reducing short-term assuming they do. I think there are a lot of variables outside Fed control that affect long-term yields and really it's the 10-year yield, the 5-year yield, even longer yields than 10-year, that affect what happens with fixed income returns. So right now I'm not convinced that I should be in fixed income, but I'm watching the situation and it's quite possible I could. It's not something I totally take off my radar screen, but at the moment I think there's plenty of opportunity in equities and I see cash as, right now, a better alternative than fixed income.

Steve Davenport: 19:18

Okay, I tend to be more conservative, I guess, in my asset allocation. I've looked at the different cutoffs right now for my long-term assets, I'm about 20% in fixed income and I'm looking at corporate bonds as an interesting spot. I believe that some of our companies are becoming bigger than nations, and so their balance sheets can accomplish a lot of things, at least of which would be paying interest on their bonds. I truly believe there are more AAA companies than there are countries. Government should learn from business, and likewise there should be a share in a research among our universities and agencies. That's kind of a long way of saying that. I think corporate bonds represent a good opportunity, and I think it's something that people should think about, because I believe that a lot of these companies have, I would say, pristine balance sheets and therefore, in the bond space, I think there's a very good chance that they're not going to default. So let me just summarize and then I'll ask you for your final comments.

Steve Davenport: 20:34

In summary, when we think about the Federal Reserve, we realize one. They have considerable power and resources which they put towards making their decisions. Ultimately, that power and resource should go towards the benefit of the people on Main Street and the people on Wall Street. Two, I think investment allocations should be set with rates moving plus or minus 1%. I think when we try to make each quarter point move be this significant event, I think we might be putting too much on our forecasting ability.

Steve Davenport: 21:15

3. Laws and regulations need to improve for insider information use and misuse. I think the Fed, just like anyone else, and there needs to be reasonable rules applied so that people don't do things that are, you know, unethical or improper, and I think it should be understood. But if it's not understood, then we need to strip, stiffen up the laws and regulations. And the last item is I think you build an allocation for your needs and your comfort level, not for Fed meeting madness. It's about you and this is your money, and I think the Fed is one variable in the long list of variables that you need to consider. But while mine is, your investments need to satisfy you. They don't need to satisfy any prognosticators views of Fed going wild or Fed going passive. So what are your comments, kellan?

Clem Miller: 22:20

Well, steve, I think you know, when I look at how folks evaluate the Fed, you know the talking heads and how much emphasis they put on Fed decisions. It almost reminds me of, you know, communism and the Soviet Union and how folks would put emphasis on five-year plans and state control and so on. And I think you know we have to realize that, even though government plays a big role in modern society and the modern economy, you know this is not, this is not state planning. We don't have the Fed planning the economy. It's just not the case. They may influence the economy, the economy influences the Fed too. So I don't think that folks should be putting as much emphasis on the Fed as a, you know, state planning organization. You know, I think people should look at the Fed as just one actor, albeit an important actor, in the overall economy. And you know.

Clem Miller: 23:35

I would just say one more thing and just go going to your point about investment allocations being tied to large rate moves. I, you know, I totally agree with that, and I would go even further to say that you know a lot of these. You know, as you mentioned, transparency is a big element in Fed policy making. Now, you know when the Fed communicates in advance that there will be Fed rate moves, then you know when they actually do it. It's not going to move markets. It will have moved markets, you know, a long time ago. So I'm not sure there's that much more information that available that comes out of a Fed decision that hasn't already been anticipated by smart market actors.

Steve Davenport: 24:29

Yeah, I think it's very complicated and I'd say the average investor doesn't need to turn the TV off when they start talking about Fed meetings. I'm not sure the average investor is getting a benefit from it. So I think you respect it and you use it as a data point, but I think the soothsayers about the Fed need to be to have the volume turned off or the channel changed.

Clem Miller: 24:59

So, everybody, you know, to all of our listeners, thank you for listening today. We really appreciate your listening to this podcast and to all of our other podcasts, and we look forward to your tuning in for our next podcast. Thank you very much, steve. Thank you 24. Bye, bye.