The markets are closely watching monetary policy. The hostilities with Iran, which has sent oil prices higher, could cause inflation, which is already above the Fed's target. Although the Fed expects one interest rate cut this year, it will depend on economic circumstances. José Torres, senior economist at Interactive Brokers, will join us live on April 30 to break down the FOMC decision and Fed Chair Jerome Powell's press conference.
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Transcription:
Transcripts are generated using a combination of speech recognition software and human transcribers, and may contain errors. Please check the corresponding audio for the authoritative record.
Gary Siegel (00:09):
Hi, and welcome to another Bond Buyer Leaders event. I'm your host, Bond Buyer Managing Editor, Gary Siegel. Today we're going to discuss the Federal Open Market Committees meeting and monetary policy. My guest is Jose Torres, Senior Economist at Interactive Brokers. Jose, welcome and thank you for joining us.
Jose Torres (00:34):
Good afternoon, Gary. It's a pleasure to join you, and thanks everyone for being here with us.
Gary Siegel (00:40):
So to the audience, there is no separate question and answer period. So if you have a question, just feel free to pop it into the Q&A question box. Jose, was there anything in the post-meeting statement or Fed Chair Jerome Powell's press conference that either surprised you or grabbed your attention?
Jose Torres (01:00):
Well, there were a lot of surprises yesterday. I thought that I didn't expect four dissenters. That was the highest amount. Going back to 1992, that was certainly a surprise. I thought that it was however appropriate, and I was pretty happy to see that three dissenters wanted to remove the easing bias from the statement. We got inflation numbers today, Gary, 3.5% on PCE, 3.2% on core PCE. Those are March numbers. Now, those numbers from February were 2.8 on headline and 3% on core prior to the war. So clearly, we are not in mirror the Fed's 2% target, especially not now after the war. So the fact that more folks, more officials, didn't want to remove that easing bias from the document. I thought that was the wrong move. I certainly disagreed with Governor Stephen Miran, who's a personal friend of mine. We've participated in panels together and him wanting to cut at this meeting.
(02:23):
The argument for the doves, Gary, has weakened significantly. In fact, this morning, we got initial unemployment claims. 57-year low. I want to say 185,000, 186,000, something like that. Continuing claims to a year low. Job gains have been good, hampered by immigration. Meanwhile, inflation, as I mentioned earlier, significantly above target and accelerating. In fact, I've been writing a lot recently and there's a chance that we're going to have a four handle on the CPI in May. So that'll be the June CPI report. If energy prices stay where they are, today they're around $104 on West Texas intermediate. So clearly we have much more of an inflation issue than an employment issue, but there's been pressure from the White House. President Trump wants lower rates, hell or high water. Of course, you have a contentious transition here with Chair Powell now looking to stay on the committee.
(03:33):
I thought that was a fifty-fifty, Gary, because the Attorney General did leave the statement about the investigation into the building renovations sort of open-ended. Said, "We can restart this investigation whenever we feel like it, " pretty much. Generally speaking, that's what it said. So of course, Chair Powell has a pretty robust legal team. He's a former Wall Street person, Carlisle group executive. So he's well connected. He has a really strong law firm and he wants to stay on. He said he wanted to maintain a low profile. I thought that was a little bit of a surprise. That was a little bit of humor too. He ducked a little bit when he said low profile. I thought that was a nice gesture. But I think that maybe he shouldn't have a low profile. Maybe he should, in the time that he does stay on as governor, whether it's three months or six months or till the end of his governorship term, which expires in 2028, I think that he could be a reasonable voice within the committee if incoming Fed chair Kevin Warsh wants to pursue an overly dovish policy, which you know what, Gary?
(04:50):
I don't think he's going to pursue because we're talking about someone who's more of an inflation fighting hawk. It just so happens, however, that he is traditionally a Republican and he was chosen by President Trump to lead the central bank. So we could be set up here for a deja vu moment where same way President Trump was upset with Powell for not cutting rates after he appointed him back in 2018. We could have a very similar situation in 2026 with inflation accelerating and Warsh being an enemy of price pressures. He may want to stand his ground against the president and not want to reduce rates. And if you look at pricing today in the Fed funds curve, yesterday was more hawkish, but today the odds of a cut and a hike by the end of the year have essentially flipped.
(05:50):
They're roughly even by the end of the year, whether we'll get one cut or one hike, and that's been debated by investors throughout yesterday afternoon, last night, and this morning. Chances of a hike did drop a little bit because the Bank of England this morning, as well as the European Central Bank pointed to risks of recession. They were really worried about activity and worried that they'd have to raise rates due to an energy shock. So that kind of sensitivity did pare back some of the hawkishness on the curve. And we're seeing today that the two year is at 3.89, the 10 year is at 4.40. Just recently, they were at 4.44 on 10s and on Tuesday we're at 3.95. So roughly not much relief, six basis points. But ladies and gentlemen, that's particularly crucial at the two-year maturity because you have a Fed funds rate at a midpoint of 3.62, lower end range at 3.50, high range at 3.75.
(06:59):
So you have a two year at 3.89. So 3.95, 3.94, that means that the Fed's next move is essentially a hike. So that's why this 3.90 level in the two year is so pivotal. And the third year is a few basis points away from making a historic high. It reached 5.01 a few hours ago right now is at 4.98. So definitely a more hawkish development across the yield curve. For some odd reason, equities are loving it. And that's been one of the failures I think of Chair Powell, Gary and his tenure, has been to reign in those animal spirits, that speculative enthusiasm that you have in markets, whether it's stocks, whether it's cryptocurrencies. A lot of people don't want to hear that, but former chair, Paul Volcker or late Paul Volcker used to talk about how those kinds of speculative enthusiasms, they propel inflationary pressures.
(08:02):
So instead of just looking at the CPI or the PC and those official government figures, having a grip on the market and what the market is doing and how fast valuation multiples are running higher over the years, that's a direct effect of the Fed pursuing easy policy. We haven't been at the Fed's target Gary in over five years. So I think Powell has just been way too loose. I think central bankers around the world have been way too easy. They've been scared to spark some volatility, let the cycle play out, have an economic slowdown. When you let cycles play out and you're not so focused on defending employment and prosperity, you actually have better medium term and longer term outcomes. I'm sure we'll talk more about that as the call progresses.
Gary Siegel (09:07):
Sorry. Sorry, I was muted. There was a lot to unpack there, Jose, but my first question, because we'll get to all of that. My first question is the acceleration in inflation completely related to the war?
Jose Torres (09:23):
Three things, definitely the war, driving energy costs higher. Food costs are going to be coming higher too. That's going to take a while. It's going to take around two or three months. At the same time, those two or three months, you're going to start having an uptick in core inflation. Number two, the tariffs. The tariffs haven't been a significant driver. Call it 20 to 30 basis points on inflation. That's been affecting core goods. And then this ferocious consumer demand that we've had that's been driving up the cost of services, that's partially due to robust capital markets. We have this K-shaped economy where we have more of the wealthier households driving more of the consumer spending expenditures. And it's not a broad expansion. It's very narrow in many aspects that you see it. It's not just with the wealth distribution differences. It's also in the market.
(10:20):
You saw the GDP print this morning. It was really driven by business investment, artificial intelligence, the same thing that's driving the S&P 500 and Wall Street higher. So I think those three things, the war, robust capital market/buoyant consumer spending, and then the tariff effect on core goods, that's really driven up services on the capital markets and consumer side, driving up goods and then energy first and then food later on the Iran war. So it's been really a broad inflationary pickup here at 3.5% of PCE and higher, that was a March number. April oil prices folks are higher than March. So expect that for April to come in at 3.7, 3.8. I mean, just a broad uptick in inflationary pressures that I thought definitely warranted more of a hawkish communication from the central bank overall, but I'm grateful that three of those centers really stood up.
Gary Siegel (11:30):
So getting back to Powell saying that he was going to keep a low profile, Jose, he said it was mostly about the investigation. Do you take him at his word on that because he said he's going to keep a low profile or do you think keeping a low profile would mean it's something else?
Jose Torres (11:51):
No, I definitely trust him in the sense that he said that he was looking to retire. He didn't seem like the type that would want to stay on. Seemed like he's really, frankly, it seems like he's had enough of the Washington shenanigans of dealing with the president and elected officials. And he's had a long career. He's getting older in age. It seemed timely for him to retire. I think it's definitely due to the investigation and the attorney general essentially leaving her options open to pursue an investigation later. So I don't know what Powell and his legal team are looking for, but maybe a written document saying that the investigation against him is closed and that anything in the future related to those investigations aren't going to happen or some kind of guarantee from the administration. I think that's what Powell's ultimately looking for before departing.
Gary Siegel (12:59):
So the fact that Powell is going to stay on the board for the time being, and there were three dissents about the bias, how does this impact Kevin Warsh's first meetings?
Jose Torres (13:19):
I think it definitely, if he's going in looking to ease, I think part of the dissenter's motivation was letting him know that there's folks on the committee that are going to push back against that. And that's something that's totally normal. Usually when you have a new Fed chair, you have some kinds of tests start to manifest and we're already seeing it. We're having this burst in inflation just as the president wants to lower rates, while at the same time a new Fed chair is going to be confirmed for second or third week of May 11th, around there. I think that's the date that he's going to be confirmed. So I think that it really points to new Fed chairs being tested. Like Chair Powell was tested when he first started. You had this market freak out. You had the Valmagedon episode in the equity markets where you had a swift 10% drawdown because of the uncertainty.
(14:22):
This is a new person. We don't know what's going to happen. Janet Yellen was pursued a really easy policy. Things were smooth. You don't know what's going to happen with Powell. And then Powell, in the beginning, he was, I think, much more of a hawk than in the beginning of his term than towards the end. But because he was more of a tighter policy focused official, he did have to deal with some of those issues like in 2018 and in 2019. He had those repo issues where overnight rates skyrocketed. He was looking to tighten the balance sheet. Measures that I thought were very, very prudent and very smart, trying to take the Federal Reserve incrementally taking it away and lowering the dependence on this treasury to finance its deficits via the Fed by lowering the balance sheet and keeping rates high. Back then, we had inflation at 2.4%, 2.5%, Gary, and that was considered too high and Powell wanted to reduce rates.
(15:31):
We had some weak employment reports, we had some weak retail sales numbers, weaker economic reports, and then that's when he turned around. But you had that showdown in the beginning where President Trump was furious. He may got mad at Treasury Secretary Steven Mnuchin. That's anecdotal evidence, of course. I don't know that for a fact, but apparently he was upset at Secretary Treasury Mnuchin for recommending Powell.
(15:58):
So I think that kind of similar showdown, that kind of deja vu could be set up here, especially with Warsh. Warsh seems to be more idealistic. He seems like he's going to stand his ground maybe a little more than Powell. Not that Powell didn't, but just that War seems like he has more of a bias and Powell is more balanced. So I wouldn't be surprised if Warsh comes in and supports tighter policy, supports winding down of the balance sheet. Chair Powell in December started increasing the balance sheet again after there was bank reserves got too low and there was concerns that those banks that are primary dealers that are dependent on by the treasury to come up and show up at those treasury auctions and pick up those bills, those notes, those bonds with those bank reserves low and the bank and the balance sheet remaining steady, there was going to be a risk that the treasury wouldn't be able to sell all of that debt.
(17:10):
So we started increasing the balance sheet, albeit just with treasury bills, but it's another way of easing. And I think that's also part of the reason why we have this resurgence in inflation, because when you start increasing the balance sheet, you're essentially, you're widening the path for the treasury to have wider deficits, to have to go into debt longer and cheaper. And that's something that Chair Powell has spoken about many times, Gary. He said that the government's debt path is unsustainable and that we ought to do something about it. So expanding the balance sheet is certainly not enabling the federal government, that's not really doing something about it. So throughout his term, he's shifted on a variety of issues. I think those repo scares really worried him. December 2018, the S&P 500 collapsed 20% in a month. So I think some of those issues, who knows what happened in the Federal Reserve, who knows how chaotic those events were?
(18:24):
But I think that sort of shaped him as he moved along to pursue easier policy. He doesn't like those shocks. It seems like he doesn't like getting blamed for those issues. Also, remember 2023, SVB, Signature Bank, First Republic, that episode, I think that also made him more worried about financial stability, about employment, about economic activity, and just be less inclined to want to raise rates or to want to tighten the balance sheet. In fact, last year, we talk about the dual mandate all the time, employment stability on one hand and price, maximum employment rather, and price stability on the other. And usually when you talk about it like that, as a human, okay, it's kind of fifty-fifty. Employment prices, half and half. Okay. But really, last year I started to realize, okay, it's looking like the Fed is more operating with a 75-25 kind of dynamic.
(19:25):
But now I'm realizing that it's more of 80 to 20, 85 to 15 in favor of employment, in favor of keeping the status quo as is in favor of not having any cyclical weakness, any kind of economic slowdown, any kind of recession, just trying to keep things stable, which it's good on one side, but it's in the medium term and long term, essentially you're not allocating resources effectively across the economy if you're maintaining artificially low rates. If you have a big balance sheet, you're not promoting responsibility across corporate actors. You're not incentivizing correct decision making. You're not widening the path for some better actors to enter industry. If some other actors have to leave due to a cyclical turn, you're not promoting resiliency amongst individuals, amongst corporates, and those are things that happen. But the market goes a lot higher and that seems what everybody wants to see and everyone wants to like.
(20:38):
Today, the S&P 500 knew all time high. Same thing for the NASDAQ 100. And if you have central banks around the world that aren't going to restrain price pressures, then that's what you're going to get. You're going to get higher asset prices, but you're not going to have shakeouts, but you will have affordability issues, you will have inequality issues and you'll have ... If the S&P is running 20% a year and paychecks are running three or four, one of the critical aspects of American society has been that ability to be born into a lower class, working class family, whether you're from here or whether you immigrate from somewhere else and really working your way up and trying to achieve the American dream, buying a home, starting a business, those things have really just become a lot harder in this kind of new school, central banking environment.
Gary Siegel (21:32):
So you said that the Fed seems to be more interested in maintaining the employment picture than inflation. Which side of the equation do you tend to worry more about at this point?
Jose Torres (21:49):
Definitely prices. I'm more of a free markets person. That's my ideology and my background. So I think that recessions, slowdowns aren't the worst thing in the world. I think Kevin Warsh is like that too, to an extent. Albeit he was a lot younger during the great financial crisis, so we don't know how those views have evolved. We may find out. But during the great financial crisis, when we were unleashing all the stimulus, fiscal monetary rates going down, balance sheet getting expanded, Kevin Warsh was worried about inflation. You had folks losing their jobs, you had foreclosures, you had a lot of economic calamity, and Wars was worried about inflation.
(22:37):
So I'm more worried about inflation because when you have too loose policy, resource allocation and the resources aren't allocated properly. There's not prices. You don't have price discovery in markets. Everything gets artificially boosted. So I definitely like the price side of the mandate more. And there are some central banks that don't have an employment mandate that they're more like the ECB, the Bank of England, they're much more worried about inflation as their top mandate, but even them, they're worried about prosperity, they're worried about businesses potentially failing, banks failing, that sort of thing. But just due to my free markets mindset, I do prefer a central bank that's more worried about inflation. I think it promotes more discipline across the economy to have that kind of restriction. And Paul Volker, and essentially we had a few recessions in the 80s due to the Fed pursuing type policy, but then you really had this economic boom 10, 20 years afterwards going into the global financial crisis after that.
(24:06):
And you had a lot of bank failures, you had a lot of job losses, you had some issues, but over time, things were better when you promote that kind of system, I think, in government.
Gary Siegel (24:20):
We know a lot can happen between now and the end of the year, Jose, but what is your base case for monetary policy for the rest of the year?
Jose Torres (24:33):
I think that rates are going to stay steady. I think that the chance of a hike is much greater than the chance of a reduction at this juncture, just given Kevin Warsh's past and who he's worked for for years, Stanley Druckenmiller, Wall Street, hedge fund, family office kind of style. These guys, their background, Chair Powell was more in the law space, he wasn't really in the trading space. That kind of trading background, you don't necessarily hate volatility. You're not worried too much about turbulence. You've learned over the years when you come from that background, you've learned how to weather a rocky road, a wavey ocean, waters that are choppy, you learn how to deal with that. So I think that given that he's from that background, I think that he's all right dealing with some volatility, whether that's in markets, whether that's in employment, whether that's in consumer spending.
(25:39):
I think that he's fine with that. And because of that, he'll be okay working with the president, even if the commander-in-chief doesn't like what he's doing. So I think we're steady to hire by year-end. Chair Powell, I didn't like when he said, just if you don't like what we're doing, just go into the market and bet against us. He said something along those lines during the meeting.
(26:09):
I didn't like that because obviously the Fed influences the treasury yields as well, but the treasury yields do agree with me that policy should be tighter. Sorry, at worst, it should be at least steady, but going lower from here with this kind of inflation and the kind of issues we have across the country and the lack of broad participation, no one really talks that much about that or the fact that we continue to have less banks across the country. So we're going more into the European model of having seven or eight banks and just a few other institutions. We used to have many more banks, over 4,000 banks. I stopped working at the FDIC in 2018, Gary, so I've lost count of the banking totals, but I'm sure that it's a lot less, a lot of M&A in banking, not broad participation. In the market, it's all tech, it's all AI.
(27:12):
We don't have broad participation. Amongst workers, paychecks, we have a few industries, Gary, in the nation that are high paying. The rate sensitive industries, the cyclically oriented industries, they're not doing as well. We have these inequality issues, and a lot of that is due not just to Chair Powell and this Federal Reserve, but just over the years and decades, I would say starting in 2008 with the Bernanke Fed and the Yellen Fed and now the Powell Fed, I think that those problems have become more pronounced. However, I will say that the original intent of these programs were to have employment recover, were to keep jobs up. But the issue is that once central bankers get used to easy policy, over time, it's very hard to then turn around and have something else. So for example, in 2015, 2016, 2017, once we've recovered all those jobs that we lost in the great financial crisis, it would've been probably prudent for the Yellen Fed to start to adopt a tighter bias.
(28:34):
And I thought Powell in the beginning, he tried to do that, but then all the powers that be really stopped him from doing that. You had the repo issues, you had the president on his back, you had volatility on Wall Street. So which central banker, hopefully Warsh, can stand up to the powers that be and really have an independent Fed and pursue tighter policy even when no one wants it. I think that's a key factor here.
Gary Siegel (29:07):
So we have a follow-up question from the audience, Jose. Could you talk from the perspective of free market ideology about how increasing levels of corporate concentration and monopoly power across sectors might affect price dynamics or reduce the impact of anti-inflationary policy?
Jose Torres (29:32):
Yeah. No, when you don't have broad participation, of course, then you do have a few firms that could control prices and lift the overall inflation level. So I absolutely think that that's a risk of pursuing too easy policy. Of course, free markets aren't perfect, and that is a risk of free markets that That the bigger do get bigger, but I don't think that that's what's been happening. I think that it's been more of the policies that have been essentially designed, I think, or maybe not designed, but they've been conducive to fewer firms like in the financial sector, fewer firms controlling more resources, controlling more of the activity, not a broader kind of landscape like we had back in the 1990s, the 1980s, we had a lot more banks. So I think that's from a free ... Am I answering that question? It was a long question.
(30:36):
Can you repeat that question again, Gary? I want to make sure I hit all the points.
Gary Siegel (30:41):
Sure. I could repeat it. Could you talk from the perspective of free market ideology about how increasing levels of corporate concentration and monopoly power across sectors might affect price dynamics or reduce the impact of anti-inflationary policy?
Jose Torres (31:04):
So if you have fewer firms, how is that going to reduce the impact? Yeah, no, I think overall that if you have anti-inflationary policy, so if you have tighter policy, I think that what could occur in this case is that you actually have potential for new entrants to come into the markets and actually have better price discovery. And I think that by failing to have anti-inflationary policies, you're essentially keeping the status quo as is, and you're not promoting responsibility and discipline amongst the firms in any particular industry that are participating in most of the transactions and most of the activity. When you don't have these cyclical shakeouts, it's hard for the competitors to come in if the existing players are being supported by easy fiscal and monetary policies.
Gary Siegel (32:14):
So Jose, you mentioned that the Fed has been trying to get inflation down to 2% for about five years, and for probably a decade before that, it was trying to get inflation up to 2%. How serious is the Fed about hitting the 2% target, or would they be satisfied with something close to that?
Jose Torres (32:40):
Well, I think that they seem to be pretty satisfied with something close to that. I don't think they're that determined to have the 2% target, even though Chair Powell has been asked about it several times throughout past meetings. And he says, "Hey, it's 2%. That's what it is. We're not changing it. " But I think that the actions, watch what they do, not what they say. The actions are that they're fine tolerating it forever and ever, and just pointing to long-term inflation expectations that are well anchored. And as long as those expectations are well anchored, well, then we can be all right with 3% inflation or 2.5% inflation or whatever it is.
(33:34):
And with a 2.4% inflation or a 2.5% inflation, this Fed, this Powell Fed was tightening pre-pandemic in that kind of environment to really be strict with the rate. But then after the pandemic and the associated shocks, it seemed that the Powell Fed wasn't looking to have any more kind of market volatility, was looking to sail smoothly, but that's not the job of the central bank. It's really the job is to defend the currency, to keep price pressures in check. And the issue with 2.5% and 3% inflation is that it compounds so fast, a lot faster than 2%.
(34:23):
Three to six to nine to 12 or two to four to six to eight, when you do that math, it's exponential. And that's why you have these affordability issues. You have consumer sentiment, the worst number released ever. And that survey goes back, I think, to 1960, University of Michigan because people keep hearing regular people, not capital markets folks like Gary and I or folks in the audience, but regular Americans, they hear on the news that, oh, inflation's coming down and markets are doing great, but their grocery bill keeps going higher. Paying at the pump is significant. And that's the compounding effects of inflation that's averaged roughly three to 4% from 2021 to now. So a lot of folks in the country are looking for outright price declines, not the rate of inflation moving from 3% to 2%, but actual price declines like 2% going to negative four, negative 5%.
(35:24):
Why can't central banks pursue a negative deflation policy? Well, because in the Great Depression, we learned that that wasn't the best idea to contract the monetary policy, the money supply. You needed the money supply to keep growing to Alec to accommodate population growth, economic growth, et cetera. So for that reason, we try to keep inflation low and in control and to have subdued inflation volatility, but we don't want it going negative. And that goes particularly to the argument that the views that we were talking about earlier about the expansion not being broad enough and being really narrow that a lot of folks, that's actually what they prefer. And if the Federal Reserve had a sider policy, then prices wouldn't have ran up this much, the price level. And I think that's a key consideration. But Wall Street, the stock market loves it. If you have a central bank that isn't really that focused on the inflation target, and it's just focused on defending prosperity and employment, the market's going to love it.
(36:35):
And back in the day, you had the bond vigilantes start to protest if the Fed had easy policy. But now you have a Treasury secretary that works very closely with the Fed and they're looking to do anything they can to make sure that yields across the entire curve stay contained. So like we mentioned earlier, you have Chair Powell coming in, buying bills the short end of the curve, suppressing the pressures there. And then you have Treasury Secretary Besson. He knows that the President wants low mortgage rates. He wants to improve home buying activity, construction levels. President Trump is a real estate former real estate guru.
(37:22):
So what kind of activities are the treasuries doing? Well, they're only really issuing bills similar to what former Fed chair and former Treasury Secretary Janet Yellen was doing as in the latter role, issuing bills because if you issue a lot of short-term paper, short-term government that 12 months or earlier, then you reduce the price discovery at the longer end of the curve, the two-year, the five-year, the 10-year, the 20-year, the third-year maturities. So that's one thing Treasure Secretary Bessent has continued. Then another thing that he's done is he started to buy back a lot of long-term debt and reissue short-term debt to really quell the pressure on the long end of the curve. So you have this kind of management system that reminds me a lot of what's been going on in Japan. They haven't really ... Occasionally, once every few years, they deal with a financial market shock.
(38:21):
In fact, just last night, one of their financial heads of one of their departments, a currency watchdog, said that if speculators come in and start to sell the Japanese yen, the currency, that the government is going to step in and they're going to start to strengthen it. So you have these kinds of control dynamics in Japan and they're extending here to the US where we want to keep things under control. But if we're following Japan's path in certain instances, like in really pursuing easy monetary and fiscal policies, and then to a certain extent, we're following the European paths in some other areas, it's important to notice what kind of economies these nations have, very weak demographics, not incentivizing childbirth, not incentivizing new business growth, economies that expand really slow. You had a stock market in Japan that had 20 years of flatness, you didn't have gains in 20 years.
(39:29):
So it's important to understand that there is a downside to trying to control all these natural forces of supply and demand.
Gary Siegel (39:42):
Are you at all worried about stagflation, Jose?
Jose Torres (39:50):
Definitely. The last two GDP reports, we've had weaker consumer spending. So I am worried that the growth is becoming ... I think here, look, the top risk is that growth is being carried by AI capital expenditures by the data centers. The companies that are doing that are not showing that much profit directly attributed to those activities. Four of them reported yesterday. Google is the only one that's having higher stock prices after they report. Amazon, Meta, Facebook, and Microsoft are all down significantly after the news. We're not seeing that this buoyant profitability from these AI investments, they're pushing up GDP numbers through the capital expenditures that are in the billions of dollars, I think 1.2 trillion or 1.4 trillion this year, probably in 2026. And then of course, they're bolstering consumer spending because you have stock market enthusiasm thinking that this is going to really drive a new renaissance in US and international expansion.
(41:05):
But if those investments fail to deliver profits, then we don't really have anything to fall back on. And that's really what I'm worried about from a stagflationary perspective, where we're going to have these higher prices, inflation. But then at the same time, we're not going to have the consumer spending buoyancy because that momentum in consumer spending comes from folks looking at their investment portfolios, seeing that it's doing well. Wow, the S&P, 25% in 2023, 22% or so in 2024, 17% again in 2025. 2026, we're already up 4.5%. May is starting tomorrow. It's not even half of the year. We're already up almost 5%.
(41:57):
Considering that we have a K-shaped economy and the wealthy folks are the ones really doing the shopping, if you have a stock market decline that's prolonged, you do have a real stagflationary worry if these AI investments fail to materialize. So I think that's definitely a risk from the stagflationary side. And that's part of the reason why the stock market as a percentage of GDP is north of 200%. It's the most ever. The stock market, remember the old school saying, Gary, oh, the stock market isn't the economy. Well, now it is, folks. This is why you can't tolerate any kind of downside in the stock market. Everyone starts going nuts. They want to bring it back up right away. Pandemic, 2022, oh, it was terrible. It was a 20% year. We recovered all the losses in 14 months. This drawdown we just had on March 30th, we just had the most significant rebound ever from oversold to overbought territory.
(43:08):
The S&P was at 63.17 on March 30th, 30 days ago, roughly. Today, it's at 71.87. So roughly 900, 880 points or something like that, higher, right? So fast in a span of 30 calendar days, roughly. So the stock market is increasingly becoming the economy, and we can't afford to have any turbulence or volatility there because then that's really going to weaken consumer spending considering that the lower and middle income cohorts don't have much discretionary spending capacity. It's really the big shareholders that do.
Gary Siegel (43:52):
What are your clients concerned about, Jose? What questions are they asking you?
Jose Torres (43:58):
Yeah, so the clients, I mean, first of all, they're asking me, who's buying this? That's been a main thing, Gary. Who is buying this market? Folks are saying, aren't we worse off now than we were on March 30th at the Lowe's? So that's a key consideration. Another key dynamic is where are interest rates going to go. A lot of folks are worried about the debt, what's going to happen with the deficit. I told CNBC folks on January 1st, 2025, New Year's Day, everyone was worried about President Trump. He had Elon Musk next to him. The Doge effect, they were going to cut government spending. I told everyone, "Folks, listen, President Trump is not a fiscal hawk. No way. The man is going to run into an issue with Elon Musk sooner or later. President Trump, he's more of a populist. He wants to give out the goodies.
(45:07):
He wants to please the crowd. That's his style." This morning, GDP, government spending drove the heaviest contribution to the headline number, 0.7% since the second quarter of 2024. So this first quarter of 2026, you really saw heavy government spending by the Trump administration. So that's another thing that people really worry about, what's going to happen with yields. And I tell them, "Don't worry too much. The treasury needs climbing stock prices to fund tax revenue. If yields get out of control, we're just going to bring out the Tokyo playbook." And if you have any kind of corrections or any kind of bear markets and stocks, you should probably buy them because we're going to come out of it on top. And stocks are really the only asset you could have that's going to offset the inflation risk.
(46:10):
I know bond buyer clients, you got a lot of your people, Gary, they're really good at spanning across the whole fixed income landscape and doing high yield stuff and looking at stuff in high yield that really should be investment grade and complicated things like that. Then you can definitely do great with bonds, but other investors that are more passive that want to wait six months before they make investment decisions and stuff, usually just buying, for example, the two-year treasury right now at 388 with a CPI in April that's going to come in at 3.7, you're not really making much money on a real basis. Real rates are pretty much at zero. And I think that's part of the issue with the monetary policy institution of just not having higher real rates, something we didn't talk about. Higher real rates incentivizes savings, planning for investment, planning for new businesses.
(47:15):
If you don't have high real rates, then there's no reason to save. You might as well just keep spending. You might as well keep investing if you already have the money. But if you're on the side that you'd like to save a little bit to get somewhere, that kind of blocks you to get there. So that's one of the dynamics. Other questions that they ask are whether the cyclically oriented areas of the market can do well. They've been doing well. I cannot give you a good reason why. Why is the Dow Jones and the Russell 2000 rallying with oil at 104, the 10 year at 440 and the two year at 389? It doesn't make any sense to me. It makes sense. Although I don't agree with the rally, why you would want to own tech stocks and semiconductors in this backdrop. The argument is that they're not as cyclical.
(48:07):
These companies have huge balance sheets. They don't really care what rates are. They can grow in any environment. And who cares about earnings multiples because over five or 10 years, these companies, they're going to grow into those multiples, so who cares? So I can understand that argument. But then with the Dow Jones and the Russell 2000 names, you don't have these growth narratives of exploding revenues and new technological renaissance. But what's been happening on Wall Street is that on the days where the tech trade, the AI trade is slow, folks get into those cyclically oriented trades to sort of balance the market a little bit. And that's what we're seeing today. Tech was a little slow off of those earnings that we got last night, so folks got into those cyclical areas of the market. So that's another thing that people ask, as well as our volatility levels, our volatility levels too low, too high.
(49:09):
I think they're way too low. I don't think folks are considering the macroeconomic risks, which are significant, but we've conditioned the investor community to ignore macroeconomic risks and just focus on the fact that money's going to come into the market all the time, and over time you're going to have higher prices. So those are some of the conversations that we have with customers.
Gary Siegel (49:37):
Well, we're out of time, so I'd like to thank the audience for tuning in and a special thanks to my guest, Jose Torres, senior economist at Interactive Brokers. Thank you everyone, and have a good afternoon.
