From Washington, this is the Macrocast, a podcast brought to you by Penta and Markets Policy Partners.
Hello and welcome to another episode of the Macrocast. I'm your host, Elon Muy, a managing director at Penta. And today I'm joined as always by Brendan Walsh and John Fagan of Markets Policy Partners. And we're also excited to introduce a special guest, Jeanna Smialek, a reporter for the New York Times. Jeanna covers the Federal Reserve for the New York Times. That's obviously one of the favorite topics here at the Macrocast. She's also the author of a new book called Limitless: The Federal Reserve Takes On a New Age of Crisis. The book is about the central bank's response to the pandemic and how much it stretched its powers. And that's actually, I think, a really great place to start our discussion because we spend so much time on this podcast talking about is the Fed going to hike or hold or pivot or overshoot. But it could really help to take a sort of 30,000-foot view of how we got here in the first place. So Jeanna, your book kind of covers the pandemic period and how the Fed threw everything it had at the economy during COVID. Now it's at a point where it has raised rates at the fastest pace in history and may have to actually turn right back around and cut rates again. How do you see all of these things being related, or do you think that they're related?
Yeah, absolutely. I think, you know, the point of my book, and as I spend a lot of time in the book sort of building up to this, is that the Fed's abilities and powers really expanded over the course of the 20th and into the 21st century in ways that made it pretty, you know, incredibly powerful by the time we hit the 2020 pandemic. And that's why it was able to throw all of sort of the spaghetti at the wall, try all these crazy things that we had never seen it do before when the pandemic struck. And so sort of the point of the book, and I think the big takeaway for me as I was reporting it, was that the Fed has so much power that I don't think is fully appreciated and will probably be asked to leverage those powers again. That was a big takeaway from the book, which very fortunately published two weeks before the banking crisis that we have just recently seen unfold, when the Fed in fact did start to use those sort of expansive powers it has again, and in a pretty creative way. And so, you know, I think in the sort of long sweep of things, this is an institution that just can do so much more than I think most people understand and really, you know, is doing those things in pretty interesting ways in order to sort of shore up the safety of the financial system and make sure that the economy gets sort of back to an even keel.
One of the things, though, that I think we're sort of grappling with is that, you know, while the Fed, you know, pulled out all the stops during the pandemic using the powers that it had accumulated over the course of recent decades, you know, there are many critics on Capitol Hill and elsewhere who say the Fed did too much. It built up all this power, it flexed its muscle, and it went too far, and now it has to sort of backtrack. Do you think that the Fed has used its power responsibly?
Yeah. So that's a really interesting question, and I think actually perhaps the most interesting facet of this conversation is less about the special emergency tools that it pulled out and more about the bond buying that it did in 2020-2021. I obviously spend a lot of my time as a reporter with the New York Times just sort of meeting with people on Wall Street and having lunches and, you know, doing the rounds. And it's been really interesting to me to start to hear — I feel like over the last six months, I've really started to hear a lot of people questioning whether the bond buying this time, as opposed to the bond buying that the Fed did after the 2008 financial crisis, was somehow different, was somehow inflationary in a way that the original iterations of bond buying weren't. And I have yet to hear like a very coherent argument for why that would have been the case, although some people will talk about like money supply issues. But I think it is the case that there's this questioning. It comes back to your point. I think there is this questioning about whether the Fed is doing things that weren't sort of historically all that normal, in that we don't fully understand, and that that came back to bite us somehow, that it somehow helped to ignite this inflation — the combination of sort of really aggressive Fed policy at a time when fiscal policy, the government, the congressional policy, and the White House policy was also quite aggressive, was pumping a lot of money into the economy, whether that combination might have somehow paired up to ignite the inflation that we're seeing now. And so I think there are going to be — you know, I don't think that the ink is dry on this one yet. I think we're going to be asking these questions in the years ahead. You know, it's just in the grand scheme of things, we're three years out from this episode, we're still kind of in the middle of the inflationary episode, and I don't think we have a really coherent answer yet. You know, we're not sort of 2000 Fed looking back on the Volcker era. I think it's going to take a, you know, a decade, maybe longer, before we really have a full comprehensive understanding of what just happened.
And just to be clear, when you're talking about the bond buying program, you're talking specifically about quantitative easing versus some of the other maybe non-traditional types of asset purchases that the Fed undertook during the pandemic?
Yeah, absolutely. Because those non-traditional programs actually didn't end up being that big. So I think you will find very few economists who would argue that they were super economically important in the sense that, you know, while it is true that the Fed sort of dabbled into corporate bond markets for the first time, it's not like they were pumping huge amounts of money in there. It was really like they were doing that to keep that market from crashing. But the sort of economically relevant thing that they did was buy Treasury bonds and buy mortgage-backed securities. And they did that in just astonishing scale. And so I think that that's what we're hearing people start to question. You know, was that too much? Did it go too far? Did it last too long? And I think that last point is one that's really salient to people right now. And so, you know, like I said, we're still kind of writing the postmortem on this, and I think we will be for a while.
John and Brendan, do you guys have a view on that? And sort of what do you feel the impact of the Fed's QE during the pandemic was? And I'm trying to remember sort of where we are in QT, quantitative tightening.
Well, I mean, one of the things that we've noticed is Brendan and I were at a hedge fund back in 2008, 2009, and you saw, you know, before quantitative easing really got going, you saw a lot of pushback on it, even in the early phases of it. QE1 way back then in the Fed history, there was enormous concern that it would be hyperinflationary. There were, you know, economists that signed a huge letter and so forth. And so I think that there's — and it didn't bear out. We saw a lot of episodes of QE over a long period of time, and that period tended to be, you know, disinflationary or, you know, secular stagnation kind of dynamics, which would coax the Fed back into QE. They could do those successive episodes because inflation was so low, and it became a regularized tool in the toolkit. I think that there's perhaps a little bit of, you know, a little bit of, you know, revisionist history. There's, you know, a lot of people that were sort of in that inflation camp said, 'See, I was right, QE is very inflationary, except QE1, 2, and 3 weren't, but this one was, so I'm right.'
I think we did a twist in there somewhere too.
Yeah, there may be some other aspects in there. You know, of course, the, you know, the supply chain disasters during COVID, when you pair up QE with all of these other factors, you know, it really goes to show QE and bond buying has some very difficult, you know, different dynamics depending on the macro backdrop and the context in which it's deployed. We've seen this in Japan. You know, they've been doing QE. They're still doing, you know, essentially those ultra-accommodative conditions, and it's just, you know, it doesn't seem to have any sort of one-size-fits-all outcome.
What do you think is the impact of the Fed starting to, and now for a while now, pull that money back out of the system? Have markets reacted to that in any way, or has it been an orderly drawdown?
Well, QT always had a little bit of a strange narrative on Wall Street. You know, the sell side would always say QE, rocket fuel for stocks. Fed does QE, stocks go up. Well, what about QT? That's bullish for stocks, too, because
it's always a good time to buy, right?
And, you know, the explanation was always, well, QT can only occur at a time when growth is really good. And, you know, it's occurring at a time now when inflation is the issue, really. And so it's a, you know, there's a lot of discussion about how the Fed is focused on rates and has focused the minds of the market on rates. And QT being this concept and this dynamic that we're not really all that comfortable with kind of operates in the background and is very, very difficult for market participants to account for.
We are still trying to wrap our arms around the inflationary period that we're currently in. But, you know, Brendan, it does seem like there are some signs that inflation is actually starting to cool. CPI came in a little bit under expectations. I think it was the 10th consecutive month of slower — or slowing, I'll put it that way — slowing inflation. What are you seeing there? Do you think we've actually turned the corner?
I think definitely the inflation that was caused by the pandemic and the supply chain constraints, especially the goods side, that's completely normalized, and actually a lot of those have turned negative. Now we're seeing a little slowdown in the service sector, but it's maybe a little stickier than, you know, than people would hope for. We also got the PPI, the producer price index, and that is very, very encouraging. That is completely normalized and has really fallen off a cliff in the last six months. And actually, if you just simply take the year-over-year CPI and do a two-month lag with the PPI, they track each other really well, which is very, very encouraging for the future for the CPI, because that kind of is indicating that we should be coming back to, you know, somewhat 2 to 3%, you know, relatively — not in the next two months, but, you know, probably by year end. The housing sector is also, the way that it's measured, it kind of works with a huge lag for the CPI, while we do get, you know, real-time data from places like Zillow and Redfin, so we know that the housing data is going to be, you know, coming off hard, and it will be a drag for the overall inflation and for the CPI. That's 40% of the overall measurement. So I think the Fed can feel good that, you know, inflation's coming off. I think Jeanna and I really do think that they're going to pause, but I think where the market is wrong is in how quickly they think that the Fed's going to cut in the second half of the year, and we think that they're going to be more resilient in holding the front on that front.
And Jeanna, I would really like to hear your take on this. This is the hugest gap, or one of the hugest gaps, in, you know, between in the macro landscape, really, where the Fed's rhetoric is and where Fed fund futures are pricing, given what you know about the Fed and about, you know, how they're rethinking their powers or understanding what the impact of their powers might be. Where do you come down on this? You know, how does it reconverge?
Yeah, you know, I think the Fed has actually been addressing this question a bit itself. Jay Powell basically got asked this during his latest press conference, and he said something to the effect of, you know, we have a different forecast for the economy than the markets do. And I think that that is a lot of where this all shakes out. You know, the Fed sees inflation being quite a bit stickier than the market. The Fed sees the economy being quite a bit more resilient than the market. And so that seems to be driving some of that discrepancy. And so I think some of the convergence is going to happen in like the actual economic data. If the Fed's more bullish bet is correct, I think that, you know, we probably see a less pessimistic path. They don't cut rates — or I don't know if it's pessimistic or optimistic, I guess it depends on what your perspective is, but I can see a world where, you know, like if their path actually comes to fruition, like I think they've told us they don't have any intention of cutting rates. You know, if the market is right and inflation comes down faster and the economy sort of falls out of bed, then, you know, clearly we're in a different world and things could be different. But, you know, it's such — I do not envy the central bank or market participants their jobs right now because it is such a hard world to predict the economy. You know, there are a bunch of big risks looming on the horizon. I think, you know, in the Fed's forecast, how do you incorporate the risk of a debt limit default? Like, how do you incorporate the risk of a Ukraine reescalation? Like, there are a bunch of — how do you incorporate the risk of a potential mid-size banking crisis? You know, there are a lot of wild cards out there.
No, it's important too because just when we look historically, the Fed is awful at predicting Fed funds futures. But the only thing that's even worse is the market predicting Fed funds futures.
Well, I think that's a great place to take a quick break here. When we come back, we're going to talk about the Fed. Of course, we'll keep that conversation going, but also dive a little bit deeper into the debt limit and what that could mean for the economy and for the Fed. We'll be right back.
And we're back with the Macrocast. We're talking with Jeanna Smialek of the New York Times and John Fagan and Brendan Walsh of Markets Policy Partners. One of the big things that Washington is dealing with right now is whether and how to raise the debt limit ahead of this June deadline that the Treasury Department has laid out. Amidst all of the wrangling between Republicans and Democrats, it seems like the Fed often gets caught in the middle as a potential backstop to the economy if the worst happens, and as a potential even mechanism for crazy things like a trillion-dollar coin. Do you know what are you seeing from the Fed right now and how it's navigating these tricky political waters? Because they certainly don't like to be in the middle of the fight.
