Michael Kao on November Fed Meeting, Treasury Refunding, & Bond Market Bear Steepening
Nov 1, 2023
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Former hedge fund manager and private investor Michael Kao joins the show to discuss the U.S. Treasury refunding announcement and the Fed's FOMC meeting. They explore the dollar yen cross, the market's reaction to Powell's press conference, and the four horsemen of economic resilience. They also critique Jay Powell's approach, analyze interest rates and bear steepening in the bond market, and discuss the issuance of US Treasury debt. The speakers propose thinking outside the box to address the bear steepening in the bond market and highlight the criticism of Janet Yellen's actions.
The Fed's higher-for-longer policy may create challenges as the rest of the world adopts a more dovish approach, potentially driving the US dollar wrecking ball.
The quarterly refunding announcement had a stimulative effect as short-dated bills are attractive to corporations and individuals seeking short-term cash flows, but macro forces driving the bond market may be more significant.
Structural wage pressures and embedded inflation expectations could lead to a wage-price spiral, necessitating a more hawkish response from the Fed to address job losses and control inflation.
Deep dives
FOMC Meeting and Powell's Remarks
The podcast discusses the recent FOMC meeting where no additional rate hike was announced by Powell. The market reacted positively to the news, with stocks responding favorably. Powell reiterated that the Fed is not considering rate cuts at this time. The key takeaway is that the Fed's stance signals a higher-for-longer policy, which may create challenges as the rest of the world adopts a more dovish approach, potentially driving the US dollar wrecking ball.
Quarterly Refunding Announcement and Treasury Issuance
The podcast covers the quarterly refunding announcement and the implications for Treasury issuance. It was expected that the Treasury would issue more bills and potentially deviate from the usual 15 to 20 percent split of bills. The announcement had a stimulative effect, as short-dated bills are attractive to corporations and individuals seeking short-term cash flows. However, the podcast highlights that the emphasis on the quarterly refunding may be overrated compared to the macro forces driving the bond market, such as higher-for-longer interest rates.
Implications of Strikes, Resilience Factors, and Inflation
The podcast explores the impact of spreading strikes in various industries and their influence on structural wage pressures. The discussion focuses on the four horsemen of economic resilience: demographic and structural underpinnings, fiscal tailwind, US consumer and corporations' rate insensitivity, and energy independence. It is noted that these factors, coupled with continued fiscal spending, could lead to a wage-price spiral and embedded inflation expectations. The conversation touches on the potential for job losses and the need for a more hawkish response from the Fed to address structural wage pressures and control inflation.
Macro Drivers and Demand Side
The podcast episode discusses the macro drivers of the economy, which are influencing the demand side. The speaker emphasizes that the economy performing better than expected is a key factor driving the demand. Additionally, the amount of money available to buy goods and services is also crucial. The podcast highlights how dynamics such as the Japanese yield curve and the strong dollar impact the ability of foreign central banks to defend their currency. It also mentions the limitations faced by commercial banks regarding their ability to issue loans and absorb more paper. Overall, these factors contribute to the arguments in favor of an upcoming recession, although the timing of it remains uncertain.
Investment Strategy: Buying Closed-Ended Funds
The podcast episode shares an investment strategy of buying closed-ended funds on COO equity as a way to have short duration current yield. The speaker reveals that these funds offer current yields of 25%, which have recently repriced to 22.5%. The discussion further explores the overall performance of senior loans and leveraged loans, highlighting a lower-than-expected default rate of 1.3%. The podcast outlines how the credit metrics of these loans have remained relatively sanguine due to resilient top lines of businesses. The speaker also emphasizes the importance of considering the capital stack and the valuation of assets in analyzing investments. The current macro environment favors short duration securities, both in equities and fixed income.
Michael Kao, former hedge fund manager and private investor, returns to On The Margin alongside Forward Guidance host Jack Farley to break down the U.S. Treasury’s quarterly refunding announcement (QRA) and Fed’s FOMC meeting that marked the first day of November.
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Michael Kao’s article discussed in the show: https://www.urbankaoboy.com/p/re-inflationoilgoldyield-curves-revisiting
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Disclaimer: Nothing discussed on On The Margin should be considered as investment advice. Please always do your own research & speak to a financial advisor before thinking about, thinking about putting your money into these crazy markets.
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