No Easy Choice: The Fed’s September Rate Decision

MIKE BARNES 0:10

Welcome to America’s Gold Authority Podcast. My name is Mike Barnes. Kevin Worsh has his eyes on inflation. A speech in Wyoming may have told us what he’s going to do in the future, and that may include interest rates going back up. Let’s talk about that with a couple of experts. Philip Diehl and Brad Chastain join me now. And Philip, you have so much career time in Washington. As the 35th director of the United States Minton, now president of U.S. Money Reserve, what do you think about the way that Warsh is handling this?

PHILIP N. DIEHL 0:40

Well, I’ll believe it when I see it. I guess I’m going to put it that way. There’s been a lot of talk from the chair before he was the chair, and now since he’s been the chair, about his commitment to maintaining um control over interest rates and over inflation rates, really. And uh and so far we haven’t seen much action in that regard. And really that statement applies to every member of the administration and all the appointees that have been uh sent to the Federal Reserve Board. We haven’t seen much in the way of action in uh in controlling inflation on uh any of their parts. We’ve seen a lot of words uh to the effect that they want to uh control inflation rates, they want to control money supply and such, but we just haven’t seen much in the way of action. So uh certainly the markets took uh uh the chairman at his word after the speech in Jackson Hole. But um so far uh we haven’t seen much that has given us given me encouragement. We’re gonna see an opportunity for him to act on those words coming up in a couple weeks when the uh when the board acts again uh or doesn’t act again at its next policy making committee. But I think what we’re gonna be seeing between now and then is the uh members of the board uh looking for any excuse possible, any piece of data that they can focus on that gives them a reason not to raise rates when they meet in two weeks.

MIKE BARNES 2:27

You mentioned inflation, and Kevin Walsh says, quote, we have work to do. Brad Chastain, in your role with U.S. Money Reserve, with all the research that you do, is inflation really that bad right now?

BRAD CHASTAIN 2:39

Well, it’s it’s higher than their target. I mean, it’s certainly in a historical, long-term historical context, um, not that high, but it in context of what we’ve seen over the last uh couple decades, it it’s getting back up there. So that’s what they’re watching. It really has to do, and we’ve talked about this before about how the 2% target kind of even came around. Um, it really has more to do with managing expectations because regardless of kind of what inflation is, it’s understood where it’s going to be. Markets over time adjust around that accordingly, right? So if it was, they said a 2.5% target, that’s not really much different than a 2% target or a 1.5% target, as long as markets kind of know what to expect and know um kind of what to plan for. So that’s the issue, is that they haven’t gotten it back down to what the target is, and that’s the thing that everybody is still looking at.

MIKE BARNES 3:33

I found it very interesting that this happened on the 100th day that Walsh has been in office, because we’ve always learned that since FDR, that 100 days for a president, his first 100 days, is when he supposedly has so much political power. But Walsh waits until after 100 days to make this announcement. Phillip, any coincidence there?

PHILIP N. DIEHL 3:53

No, I don’t think so. I think the the yardstick for a chairman is very different than it is for a president. Um really you have Federal Reserve chairs who uh come in and they inherit a board that uh they’re only one of 12 members who vote on rates, and they have to build a relationship with the other uh 11 members who they inherit. And it’s really a uh a work in progress before they can uh really have a big impact unless the president who appoints them has already put a number of like-minded people on the board. Now, Trump has done that. Uh he uh joins a board in which there are already, I believe, three other members of the board who uh the president has appointed. So he does have a friendly uh minority on the board who uh see, like the president does, that uh in fact interest rates ought to be cut. The president’s weighed in very strongly that in the teeth of the uh the of these high inflation rates uh that interest rates ought to be cut against all, I think virtually all economists and analysts advice. And obviously the Secretary of the Treasury would like to see interest rates come down. He has intervened in markets in order to keep them from going up and in hopes of getting them, in an attempt to getting them, to get them to come down here just in the last several weeks. So the the administration’s policy is very clear. It’s kind of hard to believe that uh after attempting to remove two members of the board, one in one case going all the way to the Supreme Court and being refused the ability to remove one member of the board and then turning around and trying to remove her again in an attempt to get another member of the board, that uh it’s just hard for me to imagine that they would be satisfied with a chairman who would actually then be ready to increase rates. It’s just beyond credibility to me that the administration is ready for Kevin Walsh, the chairman, to raise interest rates. And the president, just here in the last week, has said that he’s made the argument that, you know, when your credit is good, the your interest rate that you pay should go down. Well, for individuals, yes, that makes tremendous sense. It makes no sense whatsoever for a nation. That’s not how it works. The thing is, is that Powell is generally seen as a dove on interest rates. But people forget that in 2022 it was Powell’s Fed that voted for four 75-point increases in interest rates to fight inflation uh in the uh in the COVID era, four in a row in a matter of four months. That was the work of a hawk. And I could see uh Powell, and this is definitely against the conventional wisdom, I could see Powell decide to ton Hawkins if uh if the numbers uh supported it. Okay. So I could see a circumstance in which um washes hands this fall, not necessarily in September, but this fall, where he could face the possibility that he would be in the minority of his own Federal Reserve, and his hand could be forced to vote for an increase and to lead a 8-4 or even a 9-3 committee to vote to increase rates. So I think there are scenarios where um his hand could be forced to do that. And wow, if that were to happen, it would be good for markets. I think that would be it would shake up markets, but I think it would show the kind of determination we need uh to fight inflation.

MIKE BARNES 8:15

When Philip Diehl emphatically says that’s not how it works, we got to look closer at that. Brad Chastain, I know you have a graph telling us about interest rates and the GDP. Can you explain this to us?

BRAD CHASTAIN 8:26

Yeah, and in in context of long-term rates, I think it’s important to understand some relationships. I mean, when we talked about the policies that were being put in place long ago, you may remember we talked about the fact that the the administration has never even talked about trying to pay down debt. They’ve only talked about outgrowing debt. So moving GDP up so that it grows faster than debt over time. They want to do that by reducing deficits, not eliminating them, getting down to 3% of GDP and presumably glowing faster than that. If you do that over time, debt to GDP would fall. And so I think it’s kind of important to understand the relationship with rates if they are successful. And this graph, going all the way back to 1965, is showing nominal GDP. So when they say that you know the second quarter of this year GDP was 2.1% year over year, that’s real, that’s inflation adjusted. Nominals before the inflation adjustment, it was 6.5% in the quarter in quarter two of this year. Um, but you can see going way, way back that as GDP rises, rates tend to follow. They follow with a lag. They’re not correlated, they don’t move together. If GDP goes up, a lot of times rates will actually fall. They don’t have a correlated relationship, but they have what we call a co-integrated relationship where they’re tied together, they’re bound together over time, that they tend to mean revert. And what has happened, you know, going all the way back into the 60s and all the way up into the 80s, we saw nominal GDP, mostly because of the high inflation during that time, rising with rates following. And then for 45 years, as Philip mentioned, that we saw um inflation expectations come down. We saw actual disinflation, lower rates, bringing nominal GDP lower and lower over those years. And we saw rates falling during those years. And it doesn’t follow every wiggle, rates are much more stable than GDP. GDP year over year is very volatile there, but you can even average it out and it and it’s even clearer. This is a long way of saying that if you believe that the administration is going to achieve their objectives and get higher growth in the future through all of the various policies, it’s not really a cogent um economic argument to say that they should expect lower rates. And I believe that Besson actually knows that. He knows that his the policies that are to drive growth lead to higher inflation and higher rates over the long term. Now, as he says, he’s the world’s biggest bond salesman. He is never going to say that. You won’t hear those words out of his mouth because that does the opposite of what he’s trying to do. Um, you know, Ben Vernanke even said that central banking, not the treasury, but they adopted, of course, uh, is 98% talk and only 2% what actually gets done. And that’s very much what Bessent, it’s clear he’s doing. Um, if that was to move rates, those outright malpractice. Um because a $2 billion increase in what they’re already doing and buying those back, um it’s it’s just literally nothing. Um I mean, studies showing quantitative easing of buying trillion uh buying um trillions of bonds over over time, but uh has had very little impact on rates when the Federal Reserve goes into the market and buys rates. They’ve estimated there’s been several studies show about $500 billion in bond buybacks through quantitative um uh easing with the Fed has a an impact rate on the tenure of between 0.15 and 0.25, so around 0.2 percent. Um it’s minimal. And then we’re talking 4 billion per thing over over a few months. Um and so it’s it’s really it’s really nominal. But what they’re doing is very um uh negative for rates, pushing them up. It’s got to go up in a controlled manner, not get out of control, because then it breaks a whole lot of other things. But at the same time, I definitely agree they want to keep rates low on the front end too as much as possible, because increasingly that’s where all of the extra deficit is being funded at that lower end, which runs up um inflation rates. So what they say and kind of basic economics are not really um in alignment here. If they achieve higher risk growth, they really should be expecting higher rates over time. And you saw that, that’s why that we have the big bond bull market for 45 years from the early 80s to the 2008. It was it was falling nominal GDP, largely because of inflation falling during that time, and rates followed suit and it made a bond bull market. And now, as we’ve talked about a lot of time for a long time, the world doesn’t work that way anymore. And um, if they drive higher growth, then you expect a trend reversal there, which is not good for bonds over time. But to be clear, that does not mean bonds if if um you know real GDP right now by the Atlanta Fed is forecast to be about 4.7% on an annualized basis in the third quarter. You add the inflation to that, the nominal that is what matters here is over 8%. Um that does not mean when that it comes in, if that doesn’t get revised down, that all of a sudden bond yields are going to spike up to that. It’s a they’re not correlated, they could even move in the opposite direction. But if they sustain higher growth for an extended period of time, then that co-integration will is a it’s a magnet. It ultimately pulls rates towards it in the in that direction. So it remains to be seen if they’re successful, but um it’s not um a low rate policy that they’re trying to implement as they’re trying to grow the way out of debt. And right right now, rates, if you look at the equilibrium between nominal GDP and where the 10-year rate is, it’s the 10-year rate’s actually low compared to the the equilibrium for it. So um again, they there are different things that that always create a dispersion and and uh and that um variance, and one of them is the inflation pricing right now, because the nominal GDP is always backwards looking, right? So what was growth and what was inflation. Bonds at any point in time are forward looking, and right now bond the breakevens or the expected inflation rates that are priced into bond is only like 2.2% right now. So right now bonds have not started pricing in the Fed losing control of inflation in any way. And as a result, it’s actually it’s actually compressed compared to the current nominal GDP because it’s a full percentage higher uh than what the bonds are pricing in. So that so if there was the mean reversion to where it uh to reality, um then bonds actually are are lower than they technically should be.

MIKE BARNES 15:25

Brad, do you ever get frustrated and feel like if you went to Washington and talked to the proverbial hawks and doves and clear things up that they would understand that the way they do things may be all not always the right way to do things?

BRAD CHASTAIN 15:38

There’s nothing I would be able to explain to them. They they know what I just described to you. Their rhetoric may be different, but this is not um, this isn’t is not even PhD level economics that we’re talking about here. This is pretty pretty basic economics that they’re quite aware of, but um the way they signal and the way they guide uh is not necessarily in um is not necessarily congruent with the the reality for policy reasons. There if they if they were sometimes it would cause the opposite um effect that they’re trying to have.

MIKE BARNES 16:12

Let’s wrap things up by looking at the near future. Brad, tell me what’s gonna happen for September as we’re looking at what the Fed does, what the economy does, what Kevin Warsh does, what should we be watching for?

BRAD CHASTAIN 16:24

Well, everybody’s gonna be watching to see what Phillip said earlier is do they actually take action? Do they follow up the the um hard-line words about where inflation is and how it has not been moving towards the 2% target? Do they back it up with action? And right now um the markets are pricing in a coin flip. As of today, it’s about 50-50, uh, whether or not they raise um rates a while ago. Before War spoke last week, it was only about a 30% chance that they raised. And then after he spoke, it went up to about 60%. And now it’s back down to literally a coin toss because um everybody sees the inflation picture, they hear the talk, but I think they sense exactly what Philip’s been talking about that the the administration really does not want those short-term term rates going up right now. Philip, final thoughts from you.

PHILIP N. DIEHL 17:20

Yeah, I agree with Brad. I uh I’ve been expecting this uh the the markets to settle down. Uh, you know, everybody jumped at, you know, that here the the likelihood, like Brad said, went from 35 to 60 or 65 percent in the wake of of Wash’s speech. And I had to go back and look at that speech at the transcript to find the words that were different, that led the market to believe that he said something that was uh that warranted that huge reaction. And there were a few words that were different, but then I had to watch the speech to see if he said the words differently. And yeah, there was some difference in his emphasis, but that was it. And it was on the difference in his tone that they raised the, they doubled the likelihood. So I expected this you know, I expected this to fall back to 50-50 as it has, and I expect it to continue to fall. I expect it to continue to fall back to 35 percent unless we see some really hard numbers come in on inflation between now and September 15th, 16th when the committee meets. Uh like I said, uh Walsh and uh his friends, his uh compatriots on on the board are gonna be looking for every reason they can. And certainly the president is gonna be looking for every tea leaf that they can find that says, nope, we uh we don’t need to raise interest rates now. Uh let’s wait for October. And October, the October meeting will come at the end of October, days before the uh midterm elections. That’s when uh they’ll want to put it off as long as possible. Uh maybe they would raise rates then. It’s hard to imagine that they’d want to raise rates right on the eve of the election, but maybe they’d be forced to do it then. Uh otherwise it would be in December. I think they’d feel much more comfortable about putting off a decision until December. But that raises a lot of questions about the independence of this Fed waiting, making it appear to be such a political decision, waiting for another two months. And that’s really what the question is here is is this Fed truly independent? Are are interest rates and monetary policy being set by the White House, is that’s what’s happening here? Or is this Fed truly independent of those kinds of political pressures? That’s what this comes down to.

BRAD CHASTAIN 20:20

And where it impacts gold here as well, in terms of what they do is if bonds, which are still priced right now as inflation coming down with only a 2.2% inflation break even on them, if they if the bond market starts believing that the Fed is not that committed to bringing rates down, that will start pricing in where we are, which is the 3.3, 3.4% over time. That’s ultimately higher bond yields, it hurts bonds. Um, but it’s what it is also doing, it would be increasing the inflation component of that. So the real yield can, which is what bonds respond to, can actually fall even with higher rates. And all else being equal, and which never is, of course, there’s a million factors out there, but all else being equal, that’s actually a a tailwind when real rates fall. So um that’s why higher rates matter in context of which portion of the rate is moving. And if if the bond market starts thinking bul pricing in, which it hasn’t yet, that um in that inflation is not a serious, or they’re not going to seriously tackle lowering inflation. They start pricing in where inflation actually is, then um, that’s where it would be uh a tailwind for gold.

MIKE BARNES 21:35

Great discussion, guys. Philip Diehl, Brad Chastain, thanks so much for joining me today. Thank you, Mike. Thank you, Mike. Inflation. We’re gonna have to see where it’s headed and what Kevin Warsh does with interest rates. Interest rates could go up, maybe they don’t. We’re gonna have to wait and see. That’s all the time we have for today’s episode. On behalf of all of us here in the U.S. Money Reserve Studios, thank you so much for tuning in. If you have any questions or you want to learn more about today’s episode, you can call the number in our episode description and speak with one of our friendly account executives. They’re gonna be more than happy to answer any questions you may have about precious metals and the strategic role they can play in achieving a secure and comfortable financial future. I’m Mike Barnes. We will see you next time on America’s Gold Authority Podcast.