Central banks, a safeguard of financial stability who ensure shocks from funding or liquidity do not endanger the functioning of the financial system, are a critically important part of any financial ecosystem. How do they keep us safe and how do they keep things moving?
Yahoo Finance Host Jared Blikre is joined by Infrastructure Capital Advisors CEO Jay Hatfield alongside Yahoo Finance Reporter Brooke DiPalma to discuss global markets with central banks, interest rates, how the Federal Reserve may shape policy decisions moving forward, and breaking down what liquidity truly means.
Welcome to stocks and translation, your essential conversation, cutting through the market, mayhem, the noisy numbers and hyperbole to bring you the information you need for your portfolio.
Today, I am joined by Jay Hatfield.
He is Infrastructure capital advisors, CEO and also the cio of ticker scap and Brooke depalma Yahoo Finance’s own.
That’s what our guest Jay says in our word of the day is liquidity kind of a loaded term that can mean a lot of things and we’re gonna break down as much as possible.
Um Also this episode is brought to you by the number two and that’s because the 2% that’s the fed’s inflation target.
All these central banks uh act independently but they do uh confer with each other.
And the ECB, you’re saying the ECB might move first Yes, thanks, Jordan Brooke.
It’s great to be on.
So we have a totally differentiated view of economics in the market because we focus on the money supply.
And so why that’s important, normally you can ignore the money supply because it just sort of moves up with GDP, nominal GDP.
But when the FED intervenes like it did during the pandemic, you have to follow the money supply.
So if you did that, by the way, you would have traded the market absolutely perfectly.
And if you go back and look, most of our calls were pretty spot on because we were looking at monetary policy and the FED was not.
So they were calling it transitory.
So that’s the most important thing is to focus on that recently though.
Remember we had a big run up in interest rates last year in October, we started to get a little bit smarter because we tried to adapt to the markets.
And so what we did is say, well, why are rates going so high?
And what we realized is the ECB had actually taken 700 million of liquidity out within a week.
In fact, we just uncovered it by looking and then we started uh publishing the mon the global monetary base, which you can only find on our website.
All it is, is adding all the money supplies throughout the world.
And so since then, we really started focusing on Europe.
And our real thesis was that, you know, every time there’s a fed tightening cycle, something breaks.
Right.
We can all remember, particularly me who’s older, like all the breaks.
But so our theses is actually for quite a while then what’s gonna break is Europe and that’s actually sort of good.
I mean, not to wish them poorly, that’s actually good for the US because it’s deflationary.
They have to, they have 33 of their major countries are in recession.
So Lagarde yesterday even repeated that she’s essentially cutting.
I mean, the way central bankers say, like it’s almost 100% certain.
And so that makes sense because their inflation is plummeting.
And so uh the recent data and I didn’t even know this or had memorized at least is that the ECB is actually 30% of the global monetary base.
So is that bigger than the bigger the US is only 23.
So the reason why this is an interesting con or should be an interesting conversation is that it’s easy and, and proper really to, to ignore the rest of the world when it comes to equities.
Like NVIDIA is gonna drive the Chinese tech market tomorrow and, and, and admittedly that’s what we’re doing here, by the way, this is gonna be released after the NVIDIA earnings.
So we’re not gonna try to talk about it that much.
But your point taken here, we’re very us uh focused here in the US because that’s where the tech action is, right?
And it drives the rest of the world.
Like I’ve been in Europe trading stocks and say, oh my gosh, you know, European markets can smash, I better hedge my US portfolio and then the US market opens and they don’t care what was going to volatility record high.
They don’t, yeah, they’re not focused on that.
But you can’t do that with bonds and the money supply because their bonds are very similar to ours.
You know, they don’t have any tech stocks like ours, but their bonds like UK guilts are the same essentially as U as US Treasury.
So you have to look at the global market when it comes to interest rates, we’re very fixed income focused.
So we care a lot about interest rates and so the ECB is absolutely gonna cut.
And the second thing that no one ever talks about.
And this also we focused on this because I have some hedge fund friends and they’re like, oh, I don’t care if the fed cuts 25 it’s irrelevant, but there’s no dial in the New York fed to lower rates.
In other words, they have to inject liquidity into the banking system to lower the overnight rate.
Doesn’t matter who goes first and how does that then impact what happens here, who’s cutting.
So, you know, normally we wouldn’t even have this conversation because us drives the whole rest of 100% like you’re saying the opposite.
I mean, the ECB is not that old, but the first time in history where somebody else will lead like just to take the extreme example, you know, the Hong Kong has a dollar peg.
So if we raise our cut, they do it like 10 seconds later because they just have to because they’re, you know, they’re pegging against the dollar, but everybody is kind of pegging against the dollar because you don’t want your currency to get smashed.
And that’s highly inflationary.
But in this case, the ECB is gonna move, move first, which should cause the dollar to appreciate even though it hasn’t really been appreciated rec recently.
But once they actually do and that liquidity is coming in, the dollar should strengthen, which in effect uh exports deflation to the US.
OK?
And for the, for the record, I mean, us has been exporting deflation to the rest of the world for decades now.
I was just wondering if you could give us more of an overview of uh some of the different mechanisms by which the central banks operate.
Because you said the New York, the New York fed doesn’t have a button uh that says lower rates.
Uh basically they have to target the money supply.
This is something that Volcker did back in the day.
He did it explicitly.
But these, the transmission mechanism is the Federal Reserve is gonna buy bonds or they’re gonna sell them, let them roll off.
And that’s really what’s at play here.
And so the only complexity to that is there, they can do long term bonds or short term.
But I think managing, yeah, managing the fed funds rate to be in the, in the center of the, of the range.
So they’re always trading with the street.
Um And in fact, this is a surprising, it hasn’t happened before either.
The fed was injecting so much liquidity by buying long term bonds.
You know, we were God bullish when they announced that, but they did it so much, they actually had to neutralize it by borrowing it back from short term.
So they were doing this long, short term trade.
So that’s the only thing you have to watch is just what part of the balance sheet are they using to inject the liquidity with?
That reminds me of something that I noticed early on.
Well, this is actually after the fact, but it went on during the global financial crisis that the summer of 2008.
Ok, let me take us back.
Bear Stearns had failed but Lehman Brothers had not failed yet.
And everybody around the world was thinking, all right, the US is gonna raise rates.
They’re gonna drive the bus and we’re gonna embark on this interest rate hiking cycle now.
But it turns out the fed wasn’t done because they had, uh, they had enacted all these emergency lending uh facilities and that there is 300 billion shoveled over here.
But then they had to take 300 billion over here.
So they were selling treasury bills that had a huge liquidity draining effect.
And the net net is that while Lehman Brothers failed, was it direct?
I don’t know, but there was a liquidity crisis right after everybody thought things were gonna be ok. And I’m wondering, does that apply now?
Well, I think that the first thing I’d say is that very few people appreciate that the fed with their 2% target made the great financial crisis dramatically worse.
And there’s now research papers that demonstrate that so the 2% target was way too low.
So we all kind of forgot.
But the fed raised rates 17 times in a row because inflation was at right at the target.
So it didn’t used to be an averaging target, it was the limit.
Uh We do believe we’ve been very bullish about the economy over the last three years because of the um cyclical industries, housing and autos had, had a shortage, but now there isn’t a shortage and it’s starting to roll over.
So we do believe which is a bit non consensus.
The fed does not cut rates and increase liquidity that we will have a mild recession next year as autos and housing continue to moderate, which does feed through to all the the lows and the other suppliers to the housing sector.
If you look at the data, labor markets softening up.
So we think the liquidity is needed at this point.
If you just keep putting liquidity in like in 2021 you get a lot of anomalies like meme stocks and Bitcoin going to to forever.
So you don’t want to do it at the wrong time, which they were, we think you need it now really quickly.
It was completely made up by the New Zealand fed in the, in the seventies, I did not know the came from New Zealand.
So they just arbitrarily said, well, it’s got to be above zero.
So we’ll pick two and it’s really proven to be a disaster.
Um, since that was enacted in the mid two thousands, it’s terrible for the middle class.
They don’t want 10% inflation just to be clear.
That was horrible, particularly when it’s, when it’s, um, because it punishes savers.
It does and also it punishes people don’t own their own homes.
And you’re seeing that now where the low income consume consumer.
Which is, yeah.
Well, it’s, it’s, I, I have a full rate mortgage so I, I get squeezed but most people have fixed rate mortgages.
So homeowners, we’re crushing it.
They’re like, ok, my house, you know, my housing prices are up 20% but I’m not paying any more money, but most of the low income people don’t own their own house.
Obviously there’s a few that do so they’re really getting smashed.
So 10% is awful, but three or four is great because you nominal rate wages go up, gives you more discretion.
And, and so in other words, your wages go up and it gives you some discretion even if chickens higher, you can buy something else.
In terms of everyday Americans being able to afford these goods.
I mean, we’re, we’re hitting on this beef is up.
Everyday groceries are still out, they’re still moving at a higher rate.
Well, the, the problem is the average consumer is not an economist.
So, and what I mean by that is that a problem, I don’t know, we end up with a lot of it but the point being that, so we measure inflation over the last 12 months, but over the last two years or three years now, it’s been horrible.
So if your wages, so if you were in Arizona and your rent went up 30% and your wages went up 15, it doesn’t really matter that it’s stalled out and it’s not going up that much.
So that’s I think what the tale of two cities is, is that from?
And this is a political issue too, of course, because a lot of, of lower income consumers are extremely unhappy.
Jay, I’m gonna ask you to pause right there real quick.
We need to take a break.
Uh But coming up, you don’t want to miss another scintillating episode of who wore it better.
We are talking inflation.
We’re talking P CE versus CP I, you were just explaining the difference in how some of the housing components, some of the shelter components in P CE which is the fed’s preferred gauge.
Um Are different from CP I and that’s kind of what I want to explore right now.
Those, those differences because CP I gets the headlines and to be fair, it’s released two weeks earlier than P CE.
So, um there’s a little bit more data that we have for P CE.
But what are the effects that the, what, what’s the effect that the fed uh following P CE closer has on the market?
Well, we think that the feds, the fed needs to be reformed that their methodology not just the 2% target, but just looking at PC Corp is a mistake and also to be so precise, like why not 2 to 3% they’re already doing averaging.
And with this notion that they consider perfectly landed at 2% is really ridiculous.
We think so that’s the, the first problem, the, the issue with P CE.
It’s kind of interesting.
In fact, the fed chair told us what, last month he told us what P CE would be a week before.
So, um, but the reason for that is that and, and you know, well, not anybody can do it, but we do.
It is, it’s not that hard is you just take the components of CP I and PP I and then you weight them differently and you can predict PC or within 0.2 or so, like we don’t think it’s gonna be that great.
But the bad part about it, it’s sort of good because it’s a little bit less shelter, but, which is good because shelters just distorted 42% in, um, PC headline and it’s about 15% core.
So that’s good.
But when you take 7% and multiply it times seven when it’s really zero, that does raise the core rate by about 1%.
And that’s why we think inflation is contained even though um it’s not reported that way.
And the BLS number is used in P ce just at a different rate.
I I should add, there’s a lot of controversy over the way inflation is measured and um II I followed shadow stats by John Williams outfit back in the day during the global financial crisis.
And uh you know, if you measure things a little bit differently, you can come up with some pretty different results and it’s a hot button issue because it affects people’s pocketbook and that’s what we’re talking about here.
I wanna move on to liquidity because that is our word of the day.
And um there are two main measures of liquidity here.
Let me just get to the investopedia definition and I’ll pull that up for you right in a second.
Invisibilia says liquidity refers to the efficiency or ease with which an asset or security can be converted into cash into ready cash without affecting its market price.
And that’s kind of key there.
We can go into the different liquidity types and how it’s used.
But I just wanted to get your first blush uh, impression here on liquidity.
Well, I think the, the most recent example of terrible liquidity was the pandemic.
Sure.
So during the pandemic, we would trade certain res they’d be trading like, you know, $100 stock would be trading like four bucks wide.
So liquidity did melt down during the pandemic.
And in fact, I usually criticize the Fed, but it was great that they intervened and injected all that capital because we were gonna crash like we were headed to like, I mean, the economy was shut down was a certain, I mean, the market was panicking, everybody was selling.
I mean, we were gonna go to 1100 on the S and P. So, so that they did need to intervene because liquidity was horrible in all markets, you know, even large listed New York Stock exchange now, um I think there is a little bit some liquidity issues in the treasury market on the off the run side, but the equity markets are functioning well and you know, having, you know, all these, these, you know, institutions, a lot of them in New York, these hedge funds doing trading, everybody sort of hates it, but it does provide a lot of liquidity to the markets.
So you were talking about buying and selling stocks.
Uh You’re the instruments you were ta were trading were 3 to $4 wide.
That means we’re talking about spreads here and I would bet that spreads are normally a couple pennies so that you’re paying basically somebody else that spread that difference um for just executing the cur the trade.
And if you’re on the other side and you’re a market maker that might work out well for you.
But as the, as the person who wants to own that thing, um it could be a problem and I think when we talk about central bank liquidity, uh central banks want to make sure there’s enough cash in the system and we’ve been talking about that.
And then even in the capital markets, we talk about liquidity events.
Well, guess what that is?
That’s an IP O that’s when companies bring their stock to market so that the insiders of whatever unicorn can get out, they have their liquidity, they get cash for their shares while the public starts owning the shares.
Um just wondering what you’re observing in the market right now.
How do you think uh stock liquidity is for investors?
Well, 11 point to make is that I think the explosion of ETF S is really around this liquidity issue because ETF S have market makers who are arbitraging the net asset value.
And so what they do is they will, when a stock trades above par or fair value, they will, um, sell it to whoever wants to buy it and then they’ll go and buy all the under lighters and then trade, we’re ETF issuers.
So they’ll do a trade with us to offset it.
So if you look at our ETF, even the smaller ones, they’ll trade like four or five cent wide with huge liquidity on both sides and that’s provided by the ETF providers.
So because of that innovation of ETF S, um the markets become much more liquid and also investors get less nervous because it used to be like if all of your funds were vanguard and you wanted to pull the plug, you know, you put the water in, it doesn’t get executed till the end of the day.
So I think that ETF market which now kind of dominates the capital market has made the, the market significantly more liquid and particularly for stocks that are in the indices has improved liquidity.
Is there any type of liquidity that’s not widely discussed that you think our viewers should be watching?
Well, fixed income liquidity is still a problem and you were just alluded to that.
Yeah, so, and so is Powell, I think at various times over the last few years.
They don’t have to post them, not on a centralized stocks.
And so the investment banks will usually make markets that are a whole dollar wide.
Although the market, I used to trade um bonds about 15 years ago for a large hedge fund and the liquidity was terrible then because there’s no ETF S there’s no bond ETF s now the the market making in the ETF bonds creates a lot of more liquid, a lot more liquidity in the bond market.
So you get sort of shadow liquidity through the ETF market, but it is difficult to trade um individual bonds, the preferreds that we have in our funds they’re listed, so they’re better, but they’re, but actually our ETF is much easier to trade than the individual preferreds.
And so Preferreds Act a little bit like these OTC bonds with wider bid as spreads and less liquidity.
Consumer price inflation, something we’ve discussed is measured by the Bureau of Labor statistics.
While personal consumption expenditures P ce is computed by the Bureau of Economic Research.
We’ve been discussing that, but we’ve also seen both of these inflation measures tick down considerably from their pandemic highs.
So amid all these numbers, I’m throwing out, I just wanna know from you Jay to this high.
The answer to this highly loaded question who has worn the drop in inflation better?
Is it CP I or PC P CE?
Well, just one background comment on inflation that most people don’t focus on.
I think that almost all inflation can be explained by excessive monetary growth and supply shocks which are usually energy supply shocks.
So we still have a price shock going on in autos, auto insurance, up 20 repairs is up almost 20.
And um in P CE, it’s actually um a little bit more highly weighted.
So to that, that auto sector So that does raise it and it’s lower weighted to, um, shelter.
So it’s a bit of a, a grab bag.
But the primary problem with both is what I already described, which is, you know, the, be the, um, uh, yeah, the BLS numbers are used by both agencies by the be A as well.
So it’s not like they go and say, oh, you know, that terrible agency, they wait six months and you, they just take the data because they don’t have millions of people to go do this twice, right?
It would be stupid in fact.
And so that’s the primary problem is that shelter just flat out mismeasure.
They took, they used to basically use uh case studies, right?
So it was really a political, that’s why it’s delayed six months.
And so it smooths it out but it makes the fed terrible at their job because they, which is the opposite.
Yeah, they look at it like we were screaming, you know, to um your competitors and saying look, inflation is skyrocketing.
They don’t want to hear about it, but it was pretty obvious PP I is running at 10 and those other two measures are running four or five.
That’s because the shelter component wasn’t feeding in.
The other thing is core versus headline I, I would say nobody’s wearing it has both fundamentally flawed.
And I think really what should happen is, um, most people probably don’t remember Greenspan as the fed chair, but he used this thing called judgment.
So he would just look at the market and say, 00 my gosh, this is a terrible event.
He would cut rates over the weekend because the markets were down.
So he was using maybe that’s too much judgment.
But what really the fed should do is look at PP IC P I PC, do whatever adjustments are needed.
If it’s poorly calculated, have a wider range, they should be cutting right now because we’re at risk.
We think we’ll have a recession next year if they don’t.
But they don’t use judgments.
They’re easy to predict because they’re very rigid.
So I know they won’t cut, um, I believe they won’t cut in June, maybe July because we can tell that or our estimates at least are the PC core rolls down to about 2.6.
It’s probably not enough for them.
They probably want 2.5 but the labor market is weakening, they’ll cut.
But so they’re easy to predict, but they’re basically bureaucratic robots and so they can lead us into significant problems like they did in 21.
On that note, we’re gonna have to close the show here.
Uh We’re gonna talk about, uh CP I another day.
I really appreciate you stopping by here, Jay Hatfield and Brooke Depalma as well.