Today's number: four. That's how many years some octopus mothers will go without food while they guard their eggs from predators. Scientists have described these maternal instincts as an inspiration. However, Brooklyn Beckham has called it stifling.
Welcome to Prof G Markets. I'm Ed Elson. It is January 29th. Let's check in on yesterday's market vitals.
The S&P 500 hit 7,000 for the first time ever to start the day. Still, all three major indices ended the day flat after the Fed's interest rate decision. More on that in a minute. Meanwhile, the yield on 10-year Treasuries increased. Oil climbed after President Trump warned Iran that a quote massive armada is ready for violence. And Tesla stock rose after hours as the company posted a better-than-expected fourth-quarter report. However, revenue for the full year dropped for the first time in company history. Okay, what else is happening?
The Federal Reserve is holding rates steady after three consecutive cuts last year. The central bank explained that unemployment is showing quote some signs of stabilization while inflation remains quote somewhat elevated. In his remarks, Chair Powell said that the outlook for economic activity has quote clearly improved since the last meeting and that should matter for labor demand and employment over time. Meanwhile, two governors, Stephen Miran and Christopher Waller, dissented. They voted in favor of a quarter-point cut. Stocks wavered after the decision to hold, pulling back from a record high earlier in the session. All right, here to discuss the Fed's decision, we are speaking with Michael Gapen, managing director and chief US economist at Morgan Stanley. Michael, thank you very much for joining us on Prof G Markets.
So, this Fed decision, the Fed held steady pretty much as expected. There was some dissent from Stephen Miran, from Christopher Waller. Let's just start with your initial reactions. Did anything jump out to you from this Fed meeting?
Well, as you noted, the decision to stay on hold was widely expected. That was no surprise. And so I think what markets and I was looking for really was: has the Fed paused, or are they on pause? Right? In other words, was this a hawkish hold? Meaning they want to signal that they will be on hold for a long time. They don't anticipate adjusting the policy rate for a long time. Or was it, hey, things look a little bit better, but we think as inflation comes down we might ease later, right? Did they maintain an easing bias? Right, so that was really the key, I think, for all of us in markets. And what I was looking for was: was it a hawkish hold or a dovish hold? And I think we did get the latter. So the Fed certainly felt like the economy has gotten better. There are some signs that the labor market has stabilized.
There doesn't appear to be a lot of upside risk to inflation. So given that they had already moved 75 basis points, or cut three times, I think they felt like it was time to stop, look around, and see how the economy evolved.
What does that mean for rate hikes or rate cuts moving forward? And what does that mean for the battle between Donald Trump and Jerome Powell? Of course, the president has been pushing for rates to come down. How does this change things, if at all?
The way that I would describe it is: coming into the second half of last year, the Fed was cutting rates on concerns about the labor market. The Fed felt there were downside risks to employment. So they were labor-market-based cuts. But if they've upgraded the outlook, they say activity is solid. I think it's hard to deny that. And they said the labor market, or at least, is showing signs of stabilization. So I think what that means is cuts shift to inflation-based cuts.
Okay? In other words, when it's clear, if they're right that tariffs only inject temporary upward pressure on inflation, and once that pass-through is completed, inflation starts coming back down, then the Fed can normalize the policy stance further. So I would describe it as a shift from labor-market-based cuts to an outlook of inflation-based cuts. So what would mean the Fed doesn't cut is that disinflation doesn't happen, or if inflation firms further and the labor market tightens, then maybe the Fed has to even consider rate hikes. But I think Powell made it pretty clear. He said nobody is considering, at least it's not at anyone's baseline case, that there should be rate hikes. So I think in some ways the Fed is still kind of cutting off the upper end of the policy rate distribution and saying we're either on hold for a prolonged period, or inflation will decelerate and we can move our policy rate lower. As you pointed out, the administration would clearly prefer lower interest rates. So what they want may come later, but I think the Fed sees the economy as warranting lower rates, but it may take more time to get there.
If it's all about inflation now, or mostly about inflation as you say, what is the Fed's view of what we're seeing with inflation right now? Because you know it's still pretty high. The target is 2%. We're at 2.7, although there are questions over whether that 2.7 number is accurate given the shutdown that we had in the government. So I guess the question being: what does Jerome Powell think about inflation right now? Does it appear to be a real concern?
I would say with each passing month, they have greater confidence that inflation will be coming down later this year.
So the way that he's talking about it is: yes, there's clear evidence that tariffs are pushing goods prices higher. Not meaningfully higher from the Fed's perspective, but certainly they're moving higher, and that's something to watch. But there are other goods prices which are not as exposed to tariffs. Those aren't moving higher. And he said services inflation, which is mostly about domestically generated inflation, that that's decelerating. So they look at it, I think they say outside of tariffs, it looks like inflation is decelerating towards their target. So once we get through with the pass-through, then goods prices can start to come down as well, or at least stop rising. And so they have a pretty favorable outlook. So I think it's more like a matter of time for them.
How long does the pass-through last, and then how quick does inflation decelerate after? But a year ago, it was almost a year ago, right, after Liberation Day. Very different story, right? They were very concerned about upside risk to inflation and inflation firming well above the target. And I think as time has gone on, they've been able to see what part of inflation is linked to tariffs, what's happening there. Okay, it's moving higher a little bit, but the rest of inflation still looks good. In other words, no second-round effects on inflation. So I think their view is, you know, about as confident as you can get given the overall backdrop.
Well, there are some other questions I have, but I'm just interested in your perspective on that view because as an observer, if the target is 2% and they're indicating that they're comfortable with 2.7, and yet, as I've said, you know, there are third-party sources saying the number is actually higher given the shutdown and the lack of data that we've seen after the month of October that we've seen from the BLS. I guess I'm surprised that there is a sense of comfort with that number, or that that is a reason to not worry so much. I mean, it seems that the 2% number, the target, has perhaps been abandoned, or at least they don't really believe that that is the true target. What would you say to that?
So I think it's fair to still have concerns, and I think it's right to point to the fact that we don't have the entire picture on inflation. There's probably some catch-up still to be had in the January data, and certainly even into next April, and that's a legacy of the shutdown and the inability of the BLS to sample prices when they need to. So there is probably some make-up effect there. So I think we shouldn't be so quick to declare victory on inflation. I generally agree with the Fed's view, but what I would say is we should really have a watchful eye. Inflation has been above, or well above, the Fed's 2% target. I'm going on five years. How long can that happen and inflation expectations still remain stable, consistent, and low? Right? So if that market slips, if inflation slips and inflation expectations slip, getting that realigned would be costly in terms of economic output and perhaps unemployment. So I think the Fed's right, and I think the way they would answer this question, and I will answer this question, is that's why they're keeping their policy rate at least modestly restrictive.
So yes, they reduced policy rates, but they didn't get policy outright easy. They made it less restrictive. So they've left it a little restrictive, and they think that balances the pressures they're getting on inflation now versus the softness they were seeing in the labor market. Of course, we'll see if that's true, but that's the way I think they would answer it. Hey, we're not even neutral. We're not even easy. We're still restrictive on balance, and that should help guarantee that tariff pass-through is transitory.
Along these lines, more macro, another topic that's been making headlines this week is the devaluation of the dollar. The dollar fell to its lowest level in four years on Tuesday. Meanwhile, the massive run-up in gold, and a lot of people, I can't tell how much of it is real, but a lot of people are talking about the debasement trade, the devaluation of the dollar, the unsustainable deficits and debts which Jerome Powell discussed. And in concert with the massive rise in gold, it does appear that perhaps there is this kind of wholesale mistrust in US currency at this point. And Powell's response to what we've seen with gold, he said, quote, 'We don't take a strong signal from rising gold prices,' which I found interesting. And I've noticed a lot of people are talking about that and saying, 'Well, maybe you should care about gold prices.' I just wanted to get your views on what we've seen with gold this week and also Jerome Powell's response.
Well, I think the way the Fed would view it is that we're linking dollar policy and gold policy, or at least dollar movements and gold movements, together. The Fed doesn't set its policy rate to target the currency, right? So it will respond to fluctuations in the currency and what that might mean about growth in net trade or inflation, but it doesn't make dollar policy, right? Other central banks, it's different. Primarily in the emerging market world, you may actually set interest rates to help guide the currency because that generates a lot of inflation, right? The tradable sector is much more important. So I think what Powell was saying is: look, dollar policy, and de facto then, if gold is representing sustainability concerns, both of those are really Treasury policy, and so we're not supposed to comment. And that's, there's a long history of that in terms of the division between the two institutions, but...
You know, that said, let's put that aside to the premise of your question, right? There's a lot of concern out there. Let's say there's a laundry list of concerns that all end up looking like greater country risk for the United States, right? So whether it's concerns about an unsustainable fiscal profile, concerns about US policy broadly, and whether it's trade disconnections or geopolitical disconnections, right? There's a lot of concern about where US policy is going. The rest of the world holds a tremendous amount of US dollar-based assets. It's about $62 trillion that the rest of the world holds in US dollar assets, whether that's direct holdings of US corporates or bonds or equities or money markets. And so there's really no asset class where the rest of the world can say, 'Well, we don't want dollar assets anymore. We're going to sell $62 trillion and move them over here,' right? There is no other market to rebalance to. So what we think is happening is that means: well, I still have to hold dollar-based assets. The question is at what price and how do I hedge them. So the dollar gets a lot of that expression, as we would say in markets. The escape valve for pressure and concerns about US policy, whether it's the debt profile or geopolitical or otherwise, all of that is getting reflected in the dollar. So there's a number of factors that are causing dollar volatility, and yes, usually officials, whether it's the Treasury or the Fed, will get worried about rapid movements in currency markets, and we did kind of get that this week, right? So and we had comments by Treasury Secretary Bessent today: 'No, we're not intervening in favor of a weaker dollar,' right? So sometimes policymakers do have to step up to at least stabilize the situation and reduce volatility. But I would expect that these dollar concerns will be with us for some time.
And to your point, concerns about debasement of fiat currencies, and therefore that may drive demand at certain points in time for things like crypto, Bitcoin, and gold.
What did you make of the president's response to these concerns? I mean, he made a lot of headlines. He said, 'I'm not too worried about it.' He said, you know, he said this comment about the dollar goes up, it goes down. It's like a yo-yo. A lot of conclusions I think people are trying to draw out of perhaps not that meaningful words. He's just, you know, talking to a reporter. But I'd be interested to hear your response to that. I think the takeaway for a lot of people is this is a big deal. And it sounds like from what you're saying, it is a big deal. And yet the president is saying, don't worry about it. Goes up, it goes down.
Well, I think it's akin to what Treasury Secretary Bessent said in the sense of, 'Hey, we're going to at least come to you in the moment without expressing too much concern. You know, we've got a handle on the situation.' I would agree with you. I wouldn't read too much into those comments, and I would just read the totality of the administration's response to it, including what Secretary Bessent said. So it's, you know, and that said, you know, I think what the market is concerned about is if you go all the way back to the Mar-a-Lago Accord, which was viewed as generally an expression of the administration's intent on economic and trade policy. There is a lot in that document about an overvalued currency and the negative effects that that has had, say, US manufacturing employment, the outsourcing of activity outside the US. So I think investors come to the table in this discussion thinking the administration wants a weaker dollar. So they're probing: is this what you want? Is this what you wanted? And so that's where I kind of think that therefore they're hypersensitive to anything that the president or the Treasury Secretary would say around this issue.
Yeah. One last question, we'll let you go. The Fed chair is, or the new Fed chair is an open question. We thought it was going to be one of the Kevins. Now it appears it's going to be Rick Reer, or at least his chances have gone up. If we look at the prediction markets, he's at 46% probability at the moment. Do you have any thoughts on who the next Fed chair might be? And perhaps how much it matters.
So I have a stronger view on maybe who it's not than who it will be of the remaining three.
