Podcast Transcript: Dominique Dwor-Frecaut on How the Fed is Setting Policy and Why an 8% US Interest Rate is Likely

This is an edited transcript of our podcast episode with Dominique Dwor-Frecaut, published 17 June 2022. Dominique Dwor-Frecaut is a Senior Macro Strategist for Macro Hive based in Los Angeles. She has been producing alpha-generating trade ideas in FX and rates in EM and G10 at established and startup macro hedge funds in the US since 2011, including at Bridgewater. She holds a PhD in economics from the London School of Economics. In the podcast we discuss, why the Fed has lost its bearings in its inflation strategy, what investors should look out for, whether the US will go into recession in 2023, and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.

Introduction

Andrew Simon (00:01):

Hi everybody, and welcome to this week’s Macro Hive Conversations with Bilal Hafeez. I’m stepping in this week, Bilal’s partner, Andrew Simon, and I have the pleasure of having as a guest, Dominique Dwor-Frecaut, who is our senior U.S. economist and has had some incredible calls on the Federal Reserve, becoming quite famous for her, what was a very outlandish call at the time, saying the Federal have to go as high as 8% to truly bring down inflation.

Once again, for people who are not aware, Macro Hive, we’re here to help educate investors and provide investment insights for all markets, from crypto, to equities, to bonds. For all our latest views, visit macrohive.com. Remember, for those of you looking for a more high-octane product, we have Macro Hive Professional for the most sophisticated investors. From hedge funds to asset managers, to banks, to family offices, we dive in deep! What are the most important things that investors need to be concerned about? What are the short-, medium-, and long-term best trades that people should be concerned and focused on?

Let’s just get a quick recap. Obviously, we had a lot of central bank policy activity this week, and we’re seeing the consequences of some of those moves in the markets, even as we speak. The Fed moved 75 basis points in the largest move we’ve seen, since the early ’90s. ECB called an emergency meeting to try and address the blowout in peripheral spreads in interest rates between Italy, Spain, and places like Germany. This morning, on Thursday, June 16th, the SNB surprises the market with a 50-basis-point hike, the first move they’ve made in 15 years. All of this stuff, we’ve been actively reporting through Macro Hive, and our investors and clients are benefiting from that.

This past week, in addition to diving into markets and central bank policy, we also have released some very exciting reports, including a deep dive from Larry Summers, where we dive into the report, which I have to say for investors, is a little bit scary. Larry compares Paul Volcker to Jerome Powell, and the situations that Volcker was in, in the early ’80s or late ’70s, and the situation the Fed is in now. A little bit of a spoiler alert, he actually thinks we could be in a more difficult situation now, than even that Volcker had in the early ’80s and thinks that bringing inflation back down to 2% will be extremely difficult. By the way, to give him credit, he has been sounding the alarm about higher inflation for easily, the last 12 months.

In addition to the normal stuff we produce, we also released our update on the crypto market. Obviously, we’ve seen huge volatility over the past several weeks, and that continued this past week. We’ve seen Bitcoin trading down near 20,000 and Ethereum trading that low as 1000… In many cases, levels we have not seen in years. We break down as we always do, a confluence of macro factors, as well as on-chain metrics that we use, to make our general views of where we think markets are heading. Unfortunately for HODLers, those signals are still predicting a difficult market ahead, definitely worth reading. We also dive in deep where, we’re now looking at the idea of people’s cost averages in buying, and how, as people become more underwater on their investments, does that have a predictive nature of where crypto prices can go? That’s a super interesting thing and highly recommend anyone focused on crypto or in general, it’s worth reaching out to.

Let’s dive right in. We have Dominique, who hopefully a lot of people know, who’s been an incredible addition to the team over the past couple of years, and we feel honoured to have her as a key member. She’s had some incredible calls on the Federal Reserve, particularly over the last six, nine months, starting from her call saying that the Fed funds rate will have to potentially go as high as 8%. This is when most banks were saying they couldn’t see the Fed really going above 2%, and some independent researchers even saying the Fed may not be able to raise rates at all, because this will crash the economy. So far, the global economy seems to be continuing to take this in stride, and inflation unfortunately, isn’t coming down. Let’s dive in deep and see what Dominique’s updated views are. Those who don’t know, Dominique has been in financial markets for many years, and has such an incredible wide spectrum of experience, from the World Bank and IMF, to buy side, sell side for banks and hedge funds, including working also for the New York Fed, as well as an economist at Bridgewater. All that information together, has helped shape her views on why she thinks the Federal Reserve will have to go as high as 8% in order to truly bring inflation down. I’m guessing here, Larry Summers would pretty much agree with Dominique’s view. Let’s dive right in.

Hi Dominique! For a lot of people who don’t know, we actually speak every week with the week ahead, where we do a quick recap on the previous week, and obviously mainly focused on the Fed, but general central bank policy, and then what investors should be considering for the week ahead. This is our first time doing a podcast, and I guess we’re calling it an Emergency Fed market Podcast, which I think a lot of new listeners should really appreciate. If they don’t know some of your insights and calls, which a lot of investors have looked to, benefited, which at the time was a somewhat way-out-there call on Fed funds rates going up to potentially 8%. This is when most people on the street had maybe two and a half, two and three quarters. Obviously, the market is moving more and more towards your call.

Before we start, if you want to, for some new listeners, give a short summary of your background. Then we could dive into what made you think about having this call, how has that view progressed over the last few months, or what you think going forward, and take it from there?

Dominique Dwor-Frecaut (06:34):

Sure. I’ve done a little bit of everything. I’ve done policy work at the New York Fed in the Markets Group, at the IMF, the World Bank. I’ve done quite a bit with macro hedge funds, Bridgewater, to start-up macro hedge funds. I’ve also worked on the sell side for global banks in Singapore, covering non-Japan Asia, and now I have the absolute pleasure of being part of team Macro Hive.

Andrew Simon (07:08):

That’s great. I feel like the pleasure is all ours, you’ve been in an amazing addition to the team and helping to build-out the company. One quick thing before we even dive in, which is specific to this past week, why after that article in The Wall Street Journal, did you think the Fed was definitely going to go 75 basis points? These types of articles, should investors be focused and have a lot of weight around articles like this? Especially around the timing this one came out, timing ahead of future meetings? Because a lot of people on Twitter were initially saying, this is a crazy article, ignore it, they’re still going 50 basis points. You had a different view, and why did you have that different view?

Dominique Dwor-Frecaut (07:49):

Sure. I think a lot of our friends on Twitter, perhaps a bit new to the ways the Fed handles policy announcement.

Andrew Simon (07:58):

For us, it’s not our first rodeo.

Dominique Dwor-Frecaut (08:04):

Absolute metaphor, Andrew… No, but seriously. I mean the Fed has, so first of all let me explain. One of my core beliefs is that I need to look at markets from the perspective of market participants who are influential, not mine. I’m going to describe how the Fed thinks, and how it acts. It doesn’t mean that I think it’s the optimal way of doing things, it’s just they make the decision, not I, so I really need to pay attention to them.

One of the little idiosyncrasies is, they don’t like to announce policy changes at policy meetings. They always like to announce them ahead of time. Usually they do that through speeches, but they have another rule, which perhaps makes more sense, which is that they’re not supposed to open on policy tenders before each meeting. What happened this time around, is that we had two data releases that ticked the Feds. One was very, very high CPI prints, and then the other one was the University of Michigan medium term inflation expectations, that shows basically expectations are de-anchoring. That’s something else the Fed cares about a lot.

The problem is that during the pre-meeting blackout period, so then the Fed tried, and through technology, to not reach the letter of its wall on the blackout, which is to reach to a few trusted reporters. Nick Timiraos at The Wall Street Journal is one of those. Before him, it was Greg Ip. Before that, Hilsenrath. There is a very long practise, and investors need to be aware of that.

Andrew Simon (09:56):

How did you know that? Was that from your experience in New York Fed? Is that a well-known thing? Doesn’t seem to be that well known in the market, considering some fairly seasoned people were still calling for 50 basis points, and saying to ignore that. Is your view from some first-hand experience?

Dominique Dwor-Frecaut (10:13):

I mean, in terms of NDA, the New York Fed wasn’t as draconian as Bridgewater, but I still have some duty of a professional reserve, let’s say. I won’t comment on that, I’ll just say that you don’t need to be in the New York Fed to see that it’s been a long-established practise. I cannot comment about what our friends and competitors were expecting ahead of this meeting, but most people who’ve been Fed watchers for some time, know what I have been describing.

Andrew Simon (10:48):

That was a great call. I think a lot of clients, especially professional clients and prime clients, I think really benefited from that insight, and hopefully your thoughts on how the market would anticipate that, as well. Maybe let’s go back to the big call, I think you first made, in like, February? Is it February, March? What was your rationale? Maybe take us through that process.

Why a terminal rate around 8% is likely

Dominique Dwor-Frecaut (11:12):

Sure. So, three reason for the close to 8%… I mean, people joke that predicting the future is hard, for sure. I don’t want to confuse our listeners with what I call superior precision. So, three reasons, really.

First, inflation is high, and I think it’s getting entrenched. You can see that, for instance, through the broadening of the inflationary pressures. There is this measure of inflation, called the trimmed mean of inflation, where you exclude from your measure of inflation, the items with the largest price increases. It’s a way of stripping out the noise, if you will. So when inflation is limited to a few items, that measure of inflation, trimmed mean inflation, doesn’t move much. Once inflationary pressures broaden, the trimmed mean measure moves up. We’ve seen it since mid-last year, and I’d say that’s a big difference with previous episodes of high commodities prices, for instance, just before the GFC in 2008. That’s one. The second thing that is going on, is that you are starting to see a spillover from inflation to wages. You’re starting to see the relationship between wages, unemployment shift out, simply because since about Q2 last year, plus of higher inflation. It makes sense. If you are a business, you want to hire people, you really need people. Inflation is high, unemployment is low, you have to pay up. You want people, you have to pay up. Of course, you’re going to adjust your wages to take into account inflation. Really, there is no mystery here. Inflation is becoming entrenched. At the same time, you have an economy which still has a lot of momentum, because of the hyper stimulus during the pandemic. Just to give you a sense of how strong the momentum is, this fiscal year, we will have had a reduction in the budget deficit equivalent to eight percentage points of GDP, never seen before. What has never been seen before also, was the deficit in the first place, which was completely out of proportion with the pandemic. Even with this fiscal consolidation, which by the way is going to be over in a few months, because next year there’s not going to be much of a reduction in the deficit, even with that sort of fiscal consolidation, a reputable institution like the CBO, Congressional Budget Office, so bipartisan office that assesses the impacts of laws on the budget, they still expect growth to be about 3% this fiscal year. So this gives you a sense of the tremendous stimulus we’ve had, which we’re still getting through.That’s my first point.

The second reason for the 8% call, is that the Fed inflation model has been falsified by the data, and in my view has some very serious, logical flaws. It’s been falsified by the data in the sense that, this model, which is called the expectations-augmented Phillips curve, predicts that as long as inflation expectations are stable, inflation from supply shocks will turn out to be self-correcting.Obviously, this is not what has happened. Until recently, inflation expectations, whether you use the University of Michigan Index, or whether you use the Fed Index of Common Inflation Expectations, these were stable, but in the actual inflation was soaring. I think there are two logical flaws. The first, actually one logical flaw, which is a Fed is relying on variables that cannot be directly observed. Namely inflation expectations and that, because I would argue that outside of the people who respond to the University of Michigan survey, and to the Conference Board’s survey, there are no Americans who care about inflation expectations. I mean, few Americans can measure inflation, and very few of us base their investment and consumption decision on a very precise forecast of inflation. This is a really nice concept, which economists love, because I can build sophisticated model around it, but in reality, it probably doesn’t exist.The other variable that is unobserved, which I think is highly questionable from a logical perspective, is the so-called natural rate of interest. The BIS doesn’t think that concept calls water. That concept has also been the object of a very heated debate for three decades, between economists in Cambridge, UK, and Cambridge, Mass. The debate was left unresolved, with the Europeans major raising some very serious logical objections to this concept. Then even Keynes, in the 1930s, criticised this concept, which is basically a sort of modern version of the loanable fund theory. The idea that, we are not going to have inflation policy is restrictive, because the neutral interest rate r-star is low, in my view, has no logical or empirical basis. I would also add, that even by the Fed’s own standards, they have two and a half percent as a long-term Fed funds rate. They call it a neutral rate, but it is neutral because in their long-term forecast, inflation is 2%. Two and a half percent is not a neutral rate, when inflation is above 8% and rising.

Andrew Simon (17:20):

So this is kind of forcing them, a little bit, to even question the indicators or tools they’ve used in the past. And you feel like… Oh, I want to get your clarification on it. You feel that now they’re more subservient in some ways, to the market. The market’s forcing them, and obviously the market sees these high numbers, or sees continued fairly strong job growth and says, “Rates, the Fed has to be moving faster.” And the Fed says, “Okay, great. They’re right, and we will.” As opposed to taking this as a core thing as maybe, five-year inflation rates, expected inflation rates, what you’re saying it’s difficult to kind of really utilise and really measure. And so far, a lot of times that measurement has been wrong, by the way. I saw that you were mentioning, if the Fed themselves are realising that they missed inflation coming to this level, and maybe the indicators that are traditionally used, things like five-year expectations for inflation, didn’t give the signal or their signals in time, now they’re becoming more subservient to following what the market is pricing. The market’s reacting quite quickly and that’s why they had to do 75, although we probably agree that was the right call… How should investors, and how do you believe is the Fed changing their view on inflation? And how to measure inflation, as obviously a very key input, in raising rates over the last few months, if it’s the last few months?

Dominique Dwor-Frecaut (19:03):

Sure. Just one last point about my 8% forecast. 8% is my current estimate of the Taylor rule. Historically, to bring down inflation, you need to bring the Fed funds close to eight to the Taylor rule. So that’s really the reason, but back to your question, you’re spot-on. The Fed has lost its intellectual minds, if you will. It follows the markets, and the market reacts to data prints. We are going through repeated cycles where data comes out strong, which makes sense given everything we’ve said earlier about inflation and growth, the market starts pricing more than what the Fed has previously announced, and the Fed, first of all, lacks the confidence to do less than the market because inflation is so high, and then doesn’t have a sort of intellectual framework to stick to. So, they just follow the markets. We’ve gone through a couple of those cycles, and I think this is what we’re going to see until the end of the year. Probably until there is enough evidence that the Fed gradualist approach is not working, and that we need a much more proactive policy strategy.

Andrew Simon (20:19):

Okay. That’s great. I think for me, that was something very interesting to see, and for investors to understand. I guess one result to that is, is that anyone expecting volatility to come down in the near term, probably is a bad call, considering that this slightly change in their approach, being more dictated by data prints and the market, as opposed to more relying on a more medium- to long-term framework. I just had a couple questions to dive deeper on things, where you are different than maybe some other people in the street. Some people are saying, “Well, in many ways the U.S. is already in recession. My indicators show they’re already in recession.” That would be one question. Then one of the data points that people may use is, we see this huge jump in consumer credit. That means that the low to lower middle-income consumers are really getting squeezed, and they’re in a terrible position. I think you have a little bit of a different view on both of those things. Maybe you can address both those things. I know that also fits into your general framework of why you think the Fed will have to go much higher, as opposed to the economy absolutely collapsing now, which I think some people are predicting.

Why the University of Michigan consumer confidence survey tells us more about inflation than growth

Dominique Dwor-Frecaut (21:42):

Sure. If we are in a recession, it will be the first time in history we are in a recession with NFPs around 400,000. I mean, seriously, if you look at the PMIs, you look at NFP, you look at consumption, sure, the economy is slowing, but it has to because we’ve just gone through hyperstimulus. If we kept going on the same trajectory, we end up in a very bad place, but it’s still growing above trend. That’s what economic indicators are telling you.

In terms of looking ahead, what’s going to happen to economic momentum? We’ve already discussed the fact that fiscal consolidation is more or less behind us. Monetary policy remains feeble. Then there is a new development, which is giving a lot of momentum to the economy, and is not being discussed enough, which is a decline in the household savings rate, which is really striking… Never happened on that scale before, not even before the GFC.

What is happening here, is that people are spending the enormous handouts they got from the government last year, and the year before. That’s how they are making up for the decline in real income caused by inflation, that has so far been higher than wage growth. So wage growth is accelerating.

The thing is if you don’t stabilise the economy early on, if you don’t take measures to slow down growth, things acquire a momentum of their own. For instance, look at the residential real estate market. It is slowing, but it still has enormous momentum. We’re talking about increases in residential prices of between 15% to 20% on a yearly basis, against a 30-year fixed mortgage rate that has remained stuck around five and one quarter. That market still has way to go, it is cooling down, but it still remains very strong. That’s the situation we are in right now, and that’s not what is needed to bring inflation, that’s above 8%, to bring it down to 2%. You can’t do on your particular monetary policy. It doesn’t work.

Andrew Simon (24:09):

That’s a good point. I think, 30-year mortgages are closer to six now, but still, if people are anticipating 10%, 15% return still over the next 12 months, that’s still a great leverage trade to put on, even at these higher mortgage rates. I do think that these rates are starting to impact the market, no question. We all agree, and that’s what we think should be happening, and the Fed should be doing… I think your point about consumer credit, if anything is actually adding to the strength of the economy, not like the absolute horrible warning signal that the economy’s about to roll over. I’m sure that the inflation is squeezing. There’s still inflation that’s higher than wage growth. Although, wage growth, we believe is picking up. Our view is more that consumers had this ability to spend, and also, they feel relatively good still about their prospects outside. We can break down the University of Michigan consumer confidence which we… Maybe you can touch on that for two seconds, because that’s another one that people are saying indicates that we’re about to be in a recession, or we’ll look back months from now and say we were already in a recession, and this was one of the indicators. So just maybe to address that, and then we can talk

Dominique Dwor-Frecaut (25:26):

Just one last thing on the consumer-borrowing. One reason it’s not a sign of stress, is that consumers have been deleveraging since the GFC. They have plenty of time, plenty of scope to borrow more, and unfortunately, it’s happening at the worst possible moment from the point of view of monetary policy, and stabilising the economy. The University of Michigan print, okay, we have two surveys of consumer confidence, the University of Michigan, and The Conference Board. Usually they track each other quite well, but they started to diverge around the time that inflation started to accelerate. That’s because the University of Michigan survey by construction is much more sensitive to inflation, than The Conference Board survey. But, it doesn’t mean that the economy is about to roll over another tool, because historically, consumer confidence survey correlates most strongly with the demand for consumer durables.

Why higher demand for consumer durables could be the new normal

Dominique Dwor-Frecaut (26:35):

What you can see, is that the demand for consumer durables remains extremely strong. By the way, this is going to be another challenge for monetary policy. What is going on is that, we’ve changed the way we live. I mean, you and I are working from home. Sundays, many people are no longer going to movie theatres, they are buying TV sets instead. Or they’re not using public transportation. Here in the UK, we have a train strike coming up, because fewer people are taking the train. The company has to cut down on service, and is not able to increase wages. People are buying cars, they are no longer using public transportation.

All these shifts mean that demand for consumer durable, that traditionally was tied to consumer expectations, it has completely decoupled, and it remains very strong. So what the University of Michigan is actually showing you, that survey is showing you, is not that the economy is about to collapse. It’s just another sign that inflationary pressure are becoming generalised.

Andrew Simon (27:41):

Yeah, that’s a great point. And embedded in some of your comments, I was thinking, it’s also a very good point is, some of this inflation can be probably drawn back to the pandemic changing people’s behaviour. Which normally could take 10-year process of the working from home, or the services they use, but we probably were most likely heading in a lot of this direction. Now, what would take 10 years to play out, has transitioned in one year. So the things that we would normally have demand for, we don’t really have demand for. In other cases, we have huge increase in demand all at once, for certain types of products and services, global manufacturing and basically supply chains and even structurally businesses cannot react quick enough to be able to service all of those changes. That probably is another indicator of why we have inflation, and it came on so quickly and probably for a lot of people, including the Fed, why it probably was a surprise. So the next thing I kind of want to go to is, since you made this call on 8%, how has your view or framework changed over the last couple months? And what are the biggest things, you as an investor, should be thinking about, going forward? Maybe first, the last couple months, has that view changed in any way?

Dominique Dwor-Frecaut (29:09):

No. If anything, the conviction has increased. Unfortunately, I’ve been more successful at convincing investors, than convincing the Fed, but I think it should take time for the Fed to change course. So what we need to look at are a couple of things. Number one, we need to look at labour market tightness and wages, and look at measures of wages that are not biassed by changes in the composition of employment. I think one reason why people are underestimating wage growth, is that initially with the pandemic, there was a huge decrease in low-paid employment.

Now this employment is coming back, and with more low-paid workers in the workforce, average wage growth is of course lower than the underlying trend. So, we need to pay attention to measure, such as the Employment Cost Index of the Atlanta Fed median wage increases, and this measure show wages accelerating and currently on path of about 6% year on year. That’s one.

The other one that is very important, is good price inflation. We were explaining how the pandemic has collapsed in just a few months, 10 years’ worth of a gradual changes. In terms of durables, this is exactly what’s happened. But it means we need to build the global production capacity to accommodate this new demand. And it’s going to take several years, and meanwhile, good price inflation remains high.

One really crucial aspect of that, is chips, semiconductor manufacturing. Durable goods are typically very intensive in semiconductors. I feel that until we have not resolved the issue of excess demand for chips, which manufacturers tell us could take a few years, we are going to have positive, good price inflation. And of course, before the pandemic, we used to have negative goods price inflation, which absorbed some of the services inflation. Services inflation was running at more than 2%. That was okay because we had negative goods price inflation, but now with positive goods price inflation, we need services price inflation to run below 2%. And wages, very strongly correlated with services inflation, because labour is the main input for services. So, we need to bring down this wage growth from 6% and accelerating to below 2%. I can’t see how this can be done without a large increase in unemployment, in other words, hard lending.

Andrew Simon (32:05):

Right. By the way, just for the record, obviously we understand that, that will be a lot of pain for a lot of people. Especially, I think, the U.S. administration probably wanted in the short-term, which they thought could be managed, that they wanted to see wage growth and the lower middle-income earning, corking in the US. Obviously, they thought they would be able to engineer something like that, without the inflation that we’re seeing now, was that your view as well?

Dominique Dwor-Frecaut (32:34):

Well, yes. A good chunk of the issues we are dealing with really come from the fact that the pandemic happened in an election year. There was strong, political will to give a lot of support to the economy. Then we had the new administration that put in place a stimulus plan, which shocked me by itself when I saw it, I thought this is not a COVID-relief plan, this is a stimulus plan. And the plan I think, was to run the economy hot, so that people who were the constituencies of the administration, minorities, low-paid workers would see their income increase. Of course, no one expected the size of the supply shock. No one realised that there was a shift in consumption, and this finger backfired in a very, very negative way.

What investors should look out for

Andrew Simon (33:32):

Okay. Let’s look to the future. How do you see the next 3, 6, 12 months playing out from a policy, from inflation, growth, I guess even market, and maybe look to kind of wrap up from there?

Dominique Dwor-Frecaut (33:45):

Sure. We have a Fed that is very unwilling to tell people that hard landing is going to be necessary to bring down inflation. In all fairness, the Fed is having a more difficult time of it, because it has to publish this SEP, which shows what is going to happen to unemployment three years down the road. When Volcker was raising interest rates to bring down inflation, he didn’t have to do that, and I think that made it somewhat easier. So obviously, no normally wired human being wants to inflict pain on other human beings.

I think for the Fed to start implementing, so tightening that’s needed, we are going to need a lot of data points, a lot of evidence, that what they’re doing is not working. The sort of big policy shifts that I thought might be coming yesterday, actually is more likely to come next year, once it becomes clear and it can no longer be denied, that current policies are not working.

Andrew Simon (34:55):

What did you expect that they were going to announce, that you think is now going to be announced or put off to next year?

Dominique Dwor-Frecaut (35:02):

Having read the Timiraos articles in the Wall Street Journal, where he had three, not just one… He had one announcing 75 basis points, he had one which was an in-depth analysis of the policy mistakes of the Fed and the administration, and he had another one where he mentioned the possibility that the SEP was going to show higher, long-term unemployment rate, which makes absolute sense because the U.S. economy is being completely reorganised.

Dominique Dwor-Frecaut (35:33):

People have to move jobs and go to sectors that are expanding. When you have that reorganisation and shuffling around of workers, that raises the long-term rate of unemployment, it takes longer for people to find jobs. He was mentioning this possibility as well, actually he was citing Chair Powell, saying that u-star was probably higher than what is in the SEP. He was supporting Waller and Mester, mentioning that U would have to go above u-star. And he did actually, but only by 10 basis points, and there was no change in u-star, so-

Andrew Simon (36:11):

Just for our listeners, U and u-star is?

Dominique Dwor-Frecaut (36:14):

So U is unemployment, and u-star is a long-term value of unemployment, or some people call it NAIRU, non-accelerating inflation rate of unemployment. It depends on your political colour. If you are a blue person, you will call it NAIRU, if you are a red person, you might call it the natural rate of unemployment. For neutrality purposes, let’s call it the long-term rate of unemployment. So, I thought, that’s it, the Fed gets it. They are going to announce, something more hawkish than what the market is expecting. Obviously, I was wrong, I got carried away also looking at dot plots. This is a FOMC that is still very, very dovish. We will need a lot of data points to get them to change policy.

Andrew Simon (37:08):

Okay.

Dominique Dwor-Frecaut (37:09):

Meanwhile, I think we’re going to have a series of those cycles where data comes out strong, market prices more than the Fed has announced, and the Fed follows the market. I’m thinking that July is 75 basis points. Jer Powell said, 50 or 75, the market is already pricing 66. We’ll probably get to 75 before the meeting. After that, my best-case scenario is for 50-basis-point hikes, that we get a series of data points that makes the market price 50 basis points. The risk, in my view, is more to the upside, one or two, maybe 75 hikes based on continued deanchoring of expectations, or continued bad replies into University of Michigan survey, and continued inflation surprises. Not impossible, not my base-case scenario, but I think we’ll probably end the year around 4%.

Whether the US will go into recession in 2023

Andrew Simon (38:13):

Then you’re still predicting, and I think you said this for six months, a recession, but do you think that we still go into recession? I think you’re now saying middle of next year, or do you think that somehow the Fed will be able to engineer this relatively soft landing?

Dominique Dwor-Frecaut (38:35):

It’s not impossible, but it’s not likely. I mean, when you have a wage price spiral, and when you have wages at 6% that you need to bring down to below 2%, very hard to do that without a big increase in unemployment.

Andrew Simon (38:52):

Right, okay. This has been amazing, as always. Just to reiterate, that much shorter form is through Macro Hive, for our Prime, Professional clients. We tape, every weekend, Dominique’s assessment over the last week and then views, especially around central bank policy for the upcoming week. Please look out for that. Anything else, people have questions about stuff we produce, how we can work together, collaborate, please reach out. We’d love to always see any way that we can help good quality, interesting investors, we’d love to discuss. And appreciate all the positive feedback, all the feedback we’ve gotten over the last couple of years, and it’s been a great experience so… Dominique, any other last parting comments?

Dominique Dwor-Frecaut (39:38):

We love feedback! Please get back to us, especially if you disagree. Good luck to everybody on the market, and we hope to talk to as many of you, as possible.

Andrew Simon (39:49):

Okay, great. Thank you, very much. Thanks, bye!

Dominique Dwor-Frecaut (39:51):

Thank you, Andrew!

Andrew Simon (39:52):

Thank you for listening to this week’s podcast, and please subscribe to the podcast show on Apple or Spotify. Or, if you listen to the podcast already, leave a five-star rating, a nice comment, and let other people know about the show, we would be super grateful. Finally, sign up for our free newsletter, at macrohive.com/free. We’ll be back soon, so tune in then.

Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)