Hi, this is Steve Eisman. Welcome to another episode of The Real Eisman Playbook. So, one of the most important things going on these days is our oil prices, the Fed, interest rates. So I thought I would bring in my absolute favorite Fed watcher. Someone who I have known for a very, very long time and who I have to say I probably read if not every day, maybe every other day, and that is Krishna Guha of Evercore, who is Evercore's Fed watcher. Krishna, welcome to The Real Eisman Playbook.
So let's start with something simple.
Which is, we have a new Fed chairman.
Yep. He just raised rates.
Why? He just, for, you know, my viewers are all different levels. Just explain to the viewers. Okay. He raised rates. Why? Why did he raise rates?
Well, Kevin Walsh came in, you know, as Fed chair early in the summer, looked around, tried to assess, you know, where the economy was. His judgment is that inflation has been above the Fed's 2% target for too long. It's more than 5 years.
Yeah. Okay. Now, of course, a lot of things happened over that period of time. The pandemic, pretty big deal, right? Right. You know, a lot of supply disruptions and of course, also demand stimulus as we tried to get the economy going. More recently, inflation was moderating, but then we got Trump's trade wars and tariffs. Then we got a shooting war in the Middle East and higher oil prices. So, there's lots of stuff going on, not all of which is by any means under the Fed's control in the short term, like oil prices. But Walsh's view is that the Fed has kind of run out of road just to look through these shocks and keep crossing its fingers and hoping that those price shocks will prove to be temporary. Even if that is in many cases the right baseline bet, comes a certain point where you've just been above target for so long you worry that people are going to start to just expect higher inflation and then factor that in to their wage negotiations, the prices that businesses large and small set in a way that can lock it into the system, and that's what he's trying to avoid.
Do you think he made the right decision? Your personal opinion.
My own view is that the inflation data has been improving recently. Over the summer, it was somewhat cooler. I think the fact that the labor market, the jobs market is in pretty good shape is telling you that maybe it's a good time to take out some insurance on the inflation side. My view on inflation is still relatively constructive. I do think it's heading down. I do think that the tariff inflation is going to drop out of the numbers fairly soon. It's already going that way. I don't see any evidence that oil is going to create some kind of lasting inflation impulse. So, I still think inflation should gradually be coming down from here, but the idea of taking out a bit of insurance on that side seems very defensible to me.
Okay, let's dig a little deeper into the Fed. Yeah. So, Walsh comes in. He's made various speeches about, for lack of a better term, he doesn't like certain things that have been done in the past, and he's going to make changes. Yes. Why don't you tell us, like, give us a list, because it's not just one thing. Certainly isn't one thing. What are the things that he's upset about, and what type of changes does he want to make?
So Kevin Walsh sees himself as a change agent, as a new broom at the Fed, and he's not just trying to move on from the Jay Powell era that went directly before him, but in many ways he's trying to move past, in some respects, back before the last three Fed chairs. So, you know, we had quite a lot of continuity from Ben Bernanke, Janet Yellen to Jay Powell in a number of areas that Kevin Walsh doesn't feel was correct. So, to give you a few examples of this, one is the sort of way of economic thinking that dominated the Fed over this period, basically 20 years. And this is grounded in something that's called sort of new Keynesian economics and economic models and theories that sort of come under that broad school. Kevin Walsh sees himself more as a supply-sider, more in that sort of small-c conservative economist tradition. So he's looking at a lot of things in a different way to his Fed predecessors.
It sounds very esoteric. Sure. But what are the practical implications of it?
Right. So, there are different schools of thought in economics as there are in most disciplines, and you know, the Fed had been operating for some time under what we might call the kind of consensus among kind of most mainstream economists these days, which is this school of thought called so-called new Keynesian economics. Kevin Walsh thinks that this approach has a lot of shortcomings. And one of the things that he focuses on is that he thinks that developments in the economy are driven less by what happens on the demand side of the economy, the spending side if you like, right? And more by what's happening on the supply side. Now if this, you know, has some of your listeners think Ronald Reagan, you know, supply-side economics, that's the point this is coming from, that sort of more conservative economic tradition which says don't so much focus on managing demand in the economy but focus on trying to understand what's happening to the supply side, what's happening to productivity, what's happening to the incentives for people to join the workforce or work additional hours, you know, and so that's his way of thinking that's somewhat different on what the big drivers of sort of economic developments are and the kind of economic models that he wants to be referencing as guideposts to thinking about how the economy is evolving, thinking about what the Fed would be doing. But then you have some discrete additional differences. One is over the Fed's balance sheet and the other is over something called forward guidance which basically has to do...
Let's put forward guidance to the side for a second. So just for the viewers who don't know, since 2010 the Fed has done quantitative easing, let's just say multiple times, and the last time being during COVID, which means the Fed goes out and basically buys bonds to get interest rates to come way down to stimulate the economy, with the result being that the Fed's balance sheet grew pre-2008 basically from nothing to maybe it's 7 trillion now, 6 and a half trillion, something like that, it's huge.
Yeah, absolutely. Down from about 9 trillion at the peak.
Now, my personal opinion is that quantitative easing did absolutely nothing to help the actual economy, but inflated asset prices. Now, we could debate that, but that's my personal view. I'm curious whether you think that's also Walsh's view, and that's why he has a bugaboo about quantitative easing.
So, I don't agree with the premise that quantitative easing didn't have any stimulative effect on the economy. Essentially, when you're in a really deep hole, like you've had a global financial crisis or you've had a pandemic, demand is really weak. What happens is the Fed or any other central bank, they cut the policy rate, the overnight interest rate down to zero. Then what do you do? Well, the only thing you can do is to start working on pulling down longer-term interest rates. And the way you do that is by buying assets. Now, of course, that is working in part by pushing up the value of assets, creating wealth gains that then support consumer spending, right? But it's also supporting demand by lowering the corporate cost of capital, right? Because a company's borrowing rate will be the government's borrowing rate plus some kind of spread. So if the Fed buys the government bonds, pushes down the price of government borrowing, you're also going to push down the price of borrowing for companies. So they'll hire more, invest more. So I personally believe strongly that QE did contribute to demand.
But your opinion, in my opinion, matter. What does Kevin Walsh think?
So I think Kevin Walsh feels at a minimum that quantitative easing was massively overdone, that it was continued well beyond the point where the benefits outweighed the costs in his eyes. I see. Now Kevin Walsh is the kind of guy who thinks, you know, big Fed, big Fed balance sheets, part of kind of big government, it's getting in the way of private sector markets and, you know, free market price determinations. He actually agrees that there is a role for QE when markets seize up. Okay. So in the middle of the financial crisis, in the early months of the pandemic, markets just seized up. And so Kevin, I think, would be very happy to come in with QE in that kind of situation. But what he doesn't like is what the Fed did, you know, coming out of the financial crisis, coming out of the pandemic, which was to continue to do QE to try to strengthen growth a bit more, to try to strengthen the job market a bit more. His view is, you know, that kind of QE that goes on and on and on is achieving relatively little at large cost in terms of bloating out the central bank's balance sheet and asset prices.
Okay. All right. So, here he is. He's chairman of the Fed. He's got a balance sheet between 6 and a half and 7 trillion. What does he want to do? You know, when you have a 7 trillion balance sheet, it's not like you can say poof, magic, it's gone, right? So, what do you do about that?
So, my personal view is that Kevin Walsh has a longstanding conviction that over time that Fed balance sheet should be brought down. And I don't think he's given up on that objective at all. One of five task forces that he's set in motion since becoming Fed chair involving external experts is on the balance sheet and thinking about how the Fed might operate the balance sheet differently going forward. But Walsh is smart enough to understand that if he just announces tomorrow that he's going to dump a whole load of Treasury bonds and mortgage bonds into the market, he will drive long-term interest rates to the sky. Right? And as you know full well at the time we're recording this, you know, the long-term interest rates have already gone up a lot for a bunch of reasons. You know, we could discuss later on if that's of interest, but very obviously he needs to proceed carefully. This is not the moment to be scaring the market that you're going to be dumping a lot of bonds into it. I think he's going to proceed carefully. He's going to develop some plans. I think he's going to look for a window of opportunity when bond market conditions stabilize, when yields come down some, where he can start to reintroduce a plan to gradually reduce the bond holdings at the Fed and to shrink that balance sheet.
Since you brought it up, you know, since I don't know, July, the 10-year has gone from something like 4 and a half percent to today I think it was 5 point, a little bit over 5.22 at one point.
Yeah. Yeah. No, no, it's around five and a quarter as we speak.
No, it's five and a quarter now. Okay.
It's been up and down through the day.
Why do you think this has happened?
So, there are a bunch of things coming together. It's kind of the classic perfect storm, right? First of all, you have a ton of debt issuance by the AI hyperscalers, right? Now competing with all that, well, with all the debt the government has issued, right, with the treasuries. And of course, as we know, the government's running a massive deficit already, 6% of GDP, right? So the first very simple point is that there are more borrowers competing for savings, competing for capital, and so that's bidding up the rate they have to pay. It's sort of a little ironic that the private sector is crowding out government, you know, the other way, right, the other way. So that's one aspect. The second thing has to do with bond investors looking at the prospects of a multi-year AI investment boom and saying we've moved from a world where there was too much saving chasing too few investment opportunities to a world in which there's a huge demand to invest chasing a limited pool of savings, some of which is being swallowed up by the government. And that this is a kind of medium-term strong demand world where the normal interest rate is just going to need to be a little higher, the normal Fed funds rate. Sometimes people will give you a technical version of that. They'll talk about how the neutral interest rate is going to be higher. Sometimes they use the jargon r-star, but that's basically just the normal rate over the next several years. Thirdly, we have oil. And of course, you know, oil's been on its ups and downs with the US-Iran conflict. But there's been net upward pressure in oil again since the ceasefire broke down in the early summer, with diesel prices at all-time highs, 100%, is putting upward pressure on inflation and on bond yields. And as you rightly point out, you know, if you just look at the price of WTI or Brent oil, or even you just look at the pump price of gasoline, you're not getting the full picture because refined product like diesel and jet fuel has actually increased a lot more than you would think just looking at...
I think diesel prices have doubled in a relatively short period of time.
Yeah. So diesel is kind of more like if oil was closer to 200 bucks, right? You know, I mean that sort of magnitude of a move in diesel. So that the energy complex in general pushing those yields up. I do think that there is also an aspect of this that has to do with bond investors looking at the Fed and saying, you know, how far are they planning to go with these rate hikes? You mentioned at the start that the Fed has just raised rates. And one of the things that Walsh doesn't like doing is providing a lot of explanation as to how he's thinking about the world, his strategy. And you know, he hates this thing called forward guidance.
Let me stop you for just one second. So let's go back in history because there were days when the Alan Greenspan era where forward guidance was whether his suitcase had too many papers in it. When did forward guidance really start and describe to my viewers what exactly is forward guidance?
Sure. There's a sort of narrow and a broad meaning of the word. The narrow meaning of the word is essentially the central bank sort of telling markets and the public what it's going to do in the future. So we're going to raise rates three times, not more, not less, or we're going to raise rates until, you know, X happens or Y happens, right, or cut on the other way. There is this broader sense of the central bank providing the market and the public with an explanation of its strategy. What's it trying to do? How's it thinking about the economy? How's it thinking about its plans for rates in the sense not of committing to do something but in the sense of saying, you know, here are the things that we're watching and if these things move in a certain direction, you know, we'll need to raise rates more. If they move in this other direction, we will raise rates less or not at all.
Yeah. A road map. So the Fed over the last 30 years or so, if we go back from the early Greenspan era, has steadily moved in the direction of doing more of both, right? Both the general explanation of this is what we're doing, this is what we're watching, this is what we're trying to do, this is what will affect the sort of, you know, the timing and pace and extent of rate changes. And the more specific, you know, we're more or less committing to do this or to do that. This was a long journey. It actually began with Greenspan. Now some people say, well, you know, Greenspan was famously, of course, somebody who hated giving a clear answer to any question and famously once, you know, in testimony, you know, when you...
New meaning to the word cryptic.
Absolutely. You'll recall there was a famous episode when a senator said something to the effect of, well, if I've understood you correctly, Mr. Chairman, I think you're saying so and so, so and so. And Greenspan responded with words to the effect of, if you understood me clearly, I must have misspoken, because Greenspan, particularly classic early Greenspan, felt that the central bank should be aloof, should be enigmatic.
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Over time, a very solid consensus built within central banks, in academia, and in the marketplace that that actually wasn't the best way to do business. That markets work better, but policy also works better when the markets in particular and also the public understand what the central bank's trying to do, right? And can therefore also have a broad rough sense of how the central bank might respond in different developments. If the price of oil keeps going up or if the economy weakens and there are job losses...
Or if you're going to say that we're going to raise rates three times, a corporation can plan for those rate increases. So, to be very clear, you know, Ben Bernanke was the guy who came in and really brought the sort of intellectual leadership, the sort of state-of-the-art thinking to say communication, transparency from the central banks, explaining what we're doing, our so-called reaction function, which is really just our playbook, right? That this makes policy more effective. It helps us achieve the outcomes we've been charged with achieving, stable prices and full employment, right? That journey actually began earlier. It began under late Greenspan. Greenspan might have started off and enjoyed with this sort of famous, you know, obscurity or ambiguity at least sounding wise without really tipping his hand either which way. But even in the late Greenspan period, you actually began the first forward guidance. It was Greenspan who introduced what was called an easing bias or a tightening bias in the Fed statement. What that basically said is, look, we didn't change rates today, but the next move is more likely to be either a hike or a cut, right? Now that was the first piece of forward guidance. So we've been doing this for 30 years. Walsh has come in and said one thing that I think is completely right and one thing that I think is completely wrong. So what's the bit that's right? But it's right that he said this, the narrow form, strong form forward guidance where I tell you I'm going to raise rates three times, not more, not less, right? That's something you want to be careful of because the world is an uncertain place and a central bank shouldn't project or communicate more confidence about the future than it really has, right? And then you can get locked into doing stuff that you shouldn't really be doing. So what he's saying is that should be at most an emergency tool in the middle of the pandemic, in the middle of the financial crisis maybe, but nothing like that in normal times. I have a lot of sympathy with that. What I don't agree with is that he's extended this to essentially say I don't really want to be in the business of that broader general guidance around the playbook, around the strategy, around the so-called reaction function.
So, he wants to go back to mystery.
He would, at least if you take his rhetoric at face value, he would be suggesting turning the clock back on this stuff, not to Greenspan, but actually to early Greenspan.
Okay, right, with the briefcase. Maybe you should carry a briefcase with a lot of paper, not a lot of paper.
With the briefcase, with the briefcase.
And linking this to what's happening in yields at the moment, right?
My concern at the moment is that what's happening in yields isn't being caused by Kevin Walsh, it's being caused by these fundamental factors, the AI boom, the debt issuance, the war and the oil. But previous central bank chairs, at least his three predecessors, I would say arguably Greenspan at least for half of his tenure, saw it as their job to try to put some guardrails around the markets by helping the market understand the Fed's own thinking and its strategy, if not its commitment as to what it would do at those next meetings. Walsh has removed those guardrails and that has contributed in my view to rates markets running rampant over recent weeks.
