Fed Watch: Julian Brigden

The Fed is in a box. A resilient labor market demands even higher for even longer, but risks more underlying economic damage. Backing off means losing control of the bond market.

Discussion

In late 2021, Julian Brigden’s FED analysis was mission critical to the development of my “edge” regarding inflation, FED policy, and the direction of the equity market. I followed the Fed very closely at the time, but Brigden’s former DC policy colleagues provided him an inside look at FED policy well beyond anything I could develop on my own. As such, his commentary across a variety of media channels greatly enhanced my own analysis, bolstering my interpretation of public FED communication and bond market pricing of the direction of monetary policy. 18+ months deep into this tightening cycle, Brigden remains a key pillar of my Fed watching process.

In a June 27 appearance on the WTFinance podcast, Brigden confirmed in detail the thesis I have been writing about for some time: The Fed is resolved to get inflation down to 2%, and if the economy continues to run stronger than expected, then they will continue to hike…making the ultimate downturn that much worse.

Podcast Quotes & Notes

Minute 2:35: Hyper-financialization.

• In the US, equities lead capex and employment

• “There is a real risk” that if equities don’t decline soon, we won’t get the weakness in the labor market that we need to see

• If stocks stay up here, labor market remains resilient, and data continue to firm, “policymakers aren’t done”

“The core [inflation] is really determined by what happens with nominal GDP and what happens in the labor market. So if you don’t get this equity weakness and the labor market remains robust, these central banks will have to keep going. And I’m afraid that they will actually do a lot more underlying damage to the economy than they intend. But sh$t happens.”

Minute 9:25: FED’s resolve.

• Fiscal policy is likely a reason for resilience/firming in the data, but is WHY the Fed needs to do more

“If they decide not to do more. If they decide to wimp out. Fine. That’s a political decision.

“I don’t think that’s where the Fed’s head is. But if they do, that will have material consequences for the markets.”

Minute 10: Lagarde.

• Unless companies absorb higher wages via lower margins, central banks will have to continue raising rates

• The Fed is in a fight with the equity market and the profitability of corporations

• If corporations continue to protect margins, the Fed will have to continue to pound the consumer into the ground to reduce demand and shut off pricing power

Minute 25:06: 2H23 key factors to watch.

• Bank reserves and the impact from net new UST issuance. “Will they start issuing 5s, 10s, 30s?”

• Credit tightening. Dallas Fed credit survey “was bad. It was bad.” Economic growth and credit tightening don’t historically go together

• Employment momentum. Fading quickly per his own models

Minute 29:57: FED is in a box.

“We will not get on top of the underlying inflation problem until we break the back of the equity market. Do a lot, a lot of damage.

“Or, they’re unable to do that, for whatever reason. Let’s say because we just discovered with SVB they can’t drain the liquidity out of the system without breaking the back of the banks.

“So then they can’t address the equity market, which means they can’t address the underlying inflation problem. And then they lose control of the bond market.”

• Why would term premia remain negative if the Fed just demonstrated it can’t get inflation under control?

• In the late 1960s term premia blew out once the bond market called the Fed’s bluff

“I still believe in the Fed. I still think at this point they are determined to address this.

“If the data proves more resilient than the Fed believes, the beatings will continue until morale is restored. In other words, you ain’t done with rate hikes.”

• In a 7% nominal GDP growth environment, if inflation falls to 0% real GDP is 7%, WELL beyond trend

• Nominal GDP growth is determined by the labor market

• If the Fed gives up and stops hiking, they lose control of the bond market

• They have to keep hiking to retain control of the bond market and maintain credibility

Minute 38:50: Opportunistic disinflation.

• First pioneered by Greenspan in the 90s, rates stay flat for years

• The bond market is currently priced for “massive cuts” in the out years, nowhere close to the Greenspan framework

• Just holding rates where they are does huge underlying damage, as a credit market structured around ZIRP is forced to refinance to far higher interest rates