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Hey everybody, welcome to another episode of A Crude Interest, PIMCO's podcast dedicated to serving financial advisors and their clients. I'm really excited today. We've got a heavy-hitting session. I've got Rich Clarida, our global economic advisor, former vice chair of the Federal Reserve, current professor at Columbia University, sitting across the table from me. Hey Rich, thanks for joining us.
And because today's conversation is going to span both Fed and monetary policy, and we're definitely going to get into politics, I'm so lucky to have Libby Cantrill, who's our head of public policy at PIMCO. Libby, thanks for joining us today.
Thanks for having me. Also nice to be back. This is, you know, this is an episode that we have been waiting to do, Rich, because we said to ourselves, we got to have Rich back on the pod. He does such a great job, but let's wait till we get the confirmation of the new Fed chair. And I'm not going to lie, there were a few moments over the course of the last few months where I was worried we wouldn't get this done this year, but maybe, you know, maybe surprising folks is that more or less on time, we've had an orderly transition of Fed leadership. So maybe why don't we kick off there and tell us about Kevin Warsh and what you think of the confirmation and where we go from here in a Warsh Fed.
Yeah, so Kevin Warsh is very impressive. He has experience as a policy maker. He was the youngest ever Fed governor back in 2006. He left the Fed in 2010. Since then has been at the Hoover Institution out in Stanford and also advising the legendary investor Stan Druckenmiller. And importantly for our conversation, he's been a consistent critic of the Fed and monetary policy almost from the day that he left the Fed. So, Kevin has a very long paper trail. He's ambitious. He's thoughtful and he definitely has some pretty strong ideas about how he would like to change the institution. In fact, he sometimes uses the term regime change when he anticipates what he'd like to do at the Fed.
What are some of those ideas? What should we expect?
Kevin has made three criticisms of the Fed that over time he may want to address. One, he's never been a fan of the big balance sheet of quantitative easing and he's been very consistent on that. Secondly, to be blunt, he thinks Fed officials talk too much, that they rely too much on forward guidance, and that less may be more when it comes to Fed communication. And thirdly, and here Kevin's been consistent, he's been critical of Ben Bernanke, Janet Yellen, Jay Powell. He thinks the Fed has become too discretionary and does not conduct policy according to a compass, say according to a policy rule like a Taylor-type rule. So, let's go through each of these in turn. Making a decision on the balance sheet is a committee decision. It's going to require an affirmative vote of the Open Market Committee just like it will be to cut rates or to raise interest rates. Secondly, there's not really much he can do about Fed communication in the sense that Reserve Bank presidents and governors are going to give speeches and go on CNBC. He may be able to have an influence over things like the economic projections or the dots. And then when it comes to rules-based policy, the Fed already publishes twice a year its policy decision relative to policy rules. So, it's not clear what addition he would do there, but I think the key point I want our listeners to understand is that even though folks including myself tend to personalize the Fed in the person of the chair, so the Bernanke Fed or the Powell Fed, Greenspan Fed, really the Fed is a committee and by statute any material decision is going to require an affirmative vote. And so, ultimately the power of the Fed chair is the power of persuasion.
Yeah, you've been really consistent with us on that topic, just reminding us that the chair is one vote. And obviously, he inherits a whole group of governors and actually steps into time in the most recent Fed meeting, and keep me honest on this one, but I think it was the most dissents we've seen, eight-four vote on the last rate decision. So, just talk about that as a backdrop for him stepping in and where you think he's going to focus, what he's going to contend with with some of his other members.
Yeah, so I think the most recent meeting illustrates well the committee that Kevin Warsh is going to inherit. And it's a committee of capable, thoughtful people, but for the most part, especially given the hostilities in the Middle East and given frankly some pretty bad inflation data even before the hostilities commenced, it's a committee that's very much in wait-and-see mode. Three of the four dissents at the last meeting were a bit unusual in the sense that they were not dissents over the policy decision. They were dissents over the language in the decision. And the folks who voted against thought that the existing communication implies that the next move, whenever it happens, will be a cut. And they would have liked a more neutral bias to the statement. There was a dissent in the other direction to cut rates. That was now departed, or I guess as of Friday, departed governor Stephen Miron, because Kevin Warsh will take his slot on the board when he's sworn in on Friday.
Libby, just to get you in on the conversation here, one of the things I'm sort of curious about is now with Warsh having or being about to formally step into the role, are we out of the woods on the Fed independence debate or does that ensue and kind of continue into the Warsh Fed?
Yeah, I mean, this I think for a while has been one of the top questions that our clients have been asking us, particularly our foreign clients who maybe have a little bit less access to kind of the understandings of the Fed. I mean, I think our view, you know, one has been that maybe concerns over Fed independence have been a bit overstated just given what Rick said, given that the Fed chair in particular is just, of course, one of 12 votes. I would also point out that there are other guardrails that protect the Fed from being too influenced by politics. Another kind of process, you know, point is that the Senate confirmation is incredibly important, I think, as we have seen, and that is yet another kind of another check and to ensure on the president, but also to ensure Fed independence. And then also the Supreme Court, which has been pretty clear, and we'll see. The Lisa Cook decision has not, that verdict has not yet been rendered, but what they have said in oral arguments suggests...
She was the governor who was investigated. It was the mortgage.
Right. So, yes, and just to be clear, Lisa Cook is a sitting Fed governor. She's one of seven. The president has tried to fire her because of the sort of alleged mortgage fraud. This case went to the Supreme Court, and again, they have not rendered a verdict yet on it, but just from oral arguments, it looks like they're likely to sympathize with her and not with the president. And I think just to take a step back, this president has definitely pushed the norms in terms of sort of demagoguing the Fed, rhetorically kind of pushing back on the Fed. I may argue though that this is a pretty modern convention, that this idea that the president doesn't necessarily kind of attack the Fed in public has become a norm really in the last 25 years. And if you go back of course to President Nixon and Chairman Arthur Burns of the Fed, that's when there was quite a lot of tension. But actually if you go back even further and you go back to LBJ and William McChesney Martin, who was the current Fed chair, you actually saw some physical violence, or at least some physical prodding, where you actually had LBJ, you know, allegedly pushing the chairman of the Fed to the wall and arguing that he needed to lower rates because of the Vietnam War. So, again, I think the point still stands is that there is always going to be some natural tension between the White House and the Fed chair. And so, you know, just to underscore this view that we've had that we believe that sort of concerns around Fed independence have been a little bit overblown and that there are several guardrails that ensure that the Fed is actually making decisions based on data and not politics.
Definitely a good perspective and I guess we'll hope it doesn't come to physical violence.
Let's hope. Yeah. But I do think now with the successful confirmation of Kevin Warsh and sort of proceeding forward, I think that this issue of Fed independence probably at least has been sort of tabled in terms of sort of one of the top questions in our clients' minds.
And hopefully no fistfights from here.
Do you guys think that, so I think maybe a year ago when we started talking about this as Powell's term was coming up, you know, sort of felt like whoever came in as Fed chair would have a bias toward cutting just by virtue of sort of the process and who was put forward. I wonder if you think that bias sort of continues with Warsh, and then it sounds to me, Rich, just reading between the lines, that you feel like the balanced view, the wait-and-see view will probably win out when it comes to a vote. But how do you see that tension sort of playing out over the course of the year between wanting to cut and support maybe a political agenda versus maintaining a strict monetary policy?
Yeah, I think a couple things are relevant here. Because this process played out over a long period of time, the initial conditions that Warsh will inherit, I guess he's being sworn in on Friday, will be a lot different than they would have been back in January. So just several months ago before hostilities commenced in the Middle East and global oil markets were thrown into turmoil, the story, the Fed's view and really PIMCO and the markets' view of the economy is that the worst of the post-tariff inflation surge was probably in the rearview mirror, that inflation would drift back down if not to 2% then into the low twos. And Fed officials, or at least a majority, thought coming into the year that they would be cutting twice this year. And so that would have been an environment which Kevin Warsh probably could have persuaded at least six other people to support a rate cut. Now you fast forward to what he would inherit, inflation is close to 4%. We may not have seen the worst from the oil shock and higher energy prices. Moreover, as I mentioned earlier, the data that we got for inflation in December, January, and February, even before the Middle East war, it was moving in the wrong direction. You have other central banks that may be hiking, in particular the ECB, the Bank of England. And so I think given that circumstance the best Warsh can probably do for the remainder of this year is just to keep the committee on hold. I think he'll try to make a case if energy prices mean revert and we get a normalization, he'll try to make a case in 2027 that some additional rate cuts are warranted, but right now I think the path of least resistance for him will be just to preside over a wait-and-see period.
Yeah, I guess you've mentioned it a couple of times, but obviously the hostilities in Iran and that region loom large here in kind of any calculation of what's going to happen. Libby, where do we stand? Sorry to ask you the tough question, but...
Time stamp this because it is incredibly fluid.
That is a very good idea. This is Wednesday morning, the 20th, at 11:00 a.m.
Yes. Because I mean really it is that dynamic. I was just on a plane last night without Wi-Fi and of course you land and you just wonder what are the headlines going to bring. I mean I think, you know, obviously right now the Strait of Hormuz is effectively closed. Negotiations are ongoing, and I think, you know, I think for the president there's sort of three different scenarios or three different kind of options if you will. One is to basically declare victory on this and to try to retreat and pivot to, you know, the midterm elections and some sort of domestic policy agenda. That I think is just increasingly more difficult because I think strategically there will be some questions about what the US achieved. I think it's probably going to be relatively unacceptable to our allies in the Gulf, particularly to Israel, if the Iranians sort of set up this kind of tolling of cargo through the Strait. So, I think that even though the president may want to declare victory and go home and pivot away from this issue, I think it's going to be very difficult for him to do that. The other, of course, is that this is sort of this frozen conflict, a little bit like what we have in Russia and Ukraine, where you sort of see some escalation, but for all intents and purposes, the Strait is basically closed. That's also going to be difficult for the president to accept. And then you also have, I think, the sort of third option or scenario, which is this kind of escalate to de-escalate. And again, I don't think this is an attractive option either for the president, but I also think it is increasingly likely for every day that kind of goes on without a resolution. And that will look like, you know, more targeted bombing, more bombing of infrastructure, and then probably trying to force the Strait to remain open or to open up. So, I think kind of bottom line here is that, you know, the president had, I think, arguably and objectively a lot of success with the Venezuela mission. I think there was probably some, you know, confidence from that, and I think that probably some miscalculation about just the complexity of this Iranian situation. And of course, now we're here though, and there's these three scenarios or options, all of which are really not that attractive to President Trump.
When you talk to our security experts who are part of our global advisory board, and any number of your contacts in DC, I mean, how do you think about the enormity of the job of escalating to de-escalate and punching through to the other side?
Yeah, and of course, I mean, I think that it really depends on what that means. If that means troops on the ground, potentially it could mean that. Probably he'll have to go to Congress for either a direct authorization for that and or for more money. I mean, remember, and this is what I mean, I think our colleagues are always tired, exhausted of my, you know, reminding folks, but Congress has the power of the purse. Right. And while the Pentagon is well-funded through the one big beautiful bill, which allocated an extra $150 billion for it, this conflict is expensive. And so ultimately the president will have to go to Congress regardless, but if he were to actually send troops on the ground, he probably will need both for the money, but also for the authorization. So that's going to be an obstacle. And then I think also politically, and of course that's the lens through which, you know, I think the market now looks through a lot of these things, this is a very unpopular conflict. It was very unpopular to begin with. You know, a majority of Americans disapproved. It has become increasingly unpopular. So, I think that there are a lot of obstacles. I'm not trying to say this is going to be kind of a neat resolution, but I think increasingly, as again the days go by without a resolution, it just becomes more likely that this is going to be something that he at least has to really seriously consider.
Rich, what are markets telling us about how they think this will all unfold over time as you look at forward curves and what's priced into different areas of commodities or rates?
It's been a very unusual market dynamic at least in my perspective. Very much risk-on in equity markets. Equity markets hitting all-time highs. Credit spreads are tight. Yes, the Mag Seven and excitement about AI is an element of that, but earnings were very strong and markets more than recovered any sell-off after hostilities began. The dollar traded up, appreciated not enormously, but the dollar on balance has been stronger. Perhaps the view being that yes, it's a global supply shock, but the US is energy independent, and so that I think has been a factor in the markets. First and foremost at PIMCO, of course, we look at the bond market. And the bond market reaction has really featured a pretty big sell-off in rates. Now, importantly, for a variety of reasons, advanced economy bond yields going into March 1st, February 28th, were actually trending down. And so a lot of the sell-off in terms of basis point increase looks much less if you compare it to the beginning of the year. But we've seen a sell-off in rates globally. Interestingly enough in the US, not really based on expectations of much higher inflation. Now, near-term inflation, obviously, markets have priced in that we'll have a pass-through to gas and prices. But longer-term, say, inflation five years out through the inflation index market has not really moved up very much at all. And so it's been a move in real rates and to some extent in term premium. And so that I think is reflecting a couple of things. One is the countries that have been hit hardest in the sell-off are the ones that are importing a lot of energy, so that makes sense. Also, without naming particular countries, there are some that have credibility issues with regard to their fiscal policy, and those have been hit pretty hard as well. The final thing I'll say on rates is really for now three years. You know, at PIMCO, we started talking about a trading range for 10-year Treasuries back in the summer of 2023, which turned out to be the last Fed hike in that cycle. And really since then, the 10-year's been in a range at roughly 5% at the high end and 3 and 3/4 at the low end, and we're still in that range for the 10-year.
Yeah, just Professor Clarida, if you don't mind, I just want to make sure for folks listening. I think it's really interesting what you were saying about long-term inflation expectations. So actually, as we, I'm not sure exactly how they sample that, whether it's through survey data or what's embedded in the difference between, you know, certain securities in the marketplace. Those haven't moved. So actually, market participants expect us to maintain kind of the course that we'd originally expected kind of coming into this year.
Let me pierce you there, that's actually quite important, and we discussed it at length in our secular forum last week. Right. There are always going to be shocks in the world. Supply shocks happen, demand shocks happen, and so successful monetary policy is really not measured against is inflation always equal to target, is policy sufficiently credible so that expected inflation, say five years in the future, is consistent with the target. And that's really what we're seeing. And so that's actually quite important. Now, there are also surveys, and with surveys of inflation, it depends on who you ask. If you ask professional forecasters or bond market traders, they more or less just write down whatever the Fed's inflation target is. But of course, most people aren't bond traders or Fed officials. And so if you do surveys of the general public, they're very sensitive to gasoline prices. And it's a well-known phenomenon that as folks drive to and from work every day, if they see the gas is $5 a gallon and not $3.50 a gallon, that ratchets up their expectations for inflation on everything. So we're seeing that in the survey data now.
Got you. Got you. Yeah, yeah, please.
