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Afford Anything | Make Smart Money Choices
LIVESTREAM: A Former Fed Economist Reveals What's Really Happening, with Karsten Jeske (“Big ERN”)
01:03:19
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- [00:00]
A
The Fed is meeting right now as we speak. The Fed is having their September meeting. It's Tuesday and Wednesday, September 16 and 17. Tomorrow, Wednesday the 17th, they are going to announce the size of their rate cut. Right now, the markets are pricing in an over 90% probability of a quarter point rate cut and 8 or 9% probability that it would be even a half point. There's essentially a 100% probability that there will be a rate cut and we will have confirmation of that on Wednesday, September 17th. So what does that mean? We haven't had a rate cut in a very long time. How's that going to affect you? If you are thinking about buying or selling a home, should you make a move? If you have a bond allocation in your portfolio, how should you think about it? What's going on at the Fed generally? Is there more of a culture of dissent right now and what does that mean for all of us? Why are there such big jobs revisions and how does that impact Fed decisions? To understand all of this and more today, we are talking with Karsten Jeska, a former Federal Reserve economist who spent eight, eight years at the Fed. Eight years inside the central bank. And after that he spent another decade on Wall Street. He's going to explain why the jobs numbers that you've been hearing are wrong. What happened, what went wrong. He's going to talk about why high interest rates might actually be causing the very inflation that we are trying to fight, at least when it comes to housing. And he talks about why we should buy the rumor, sell the news. What does that mean? Welcome to the Afford Anything podcast. The show that knows you can afford anything, but not everything. This show covers five financial psychology, increasing your income, investing, real estate, and entrepreneurship. It's double I fire. I'm your host, Paula Pant. Last week I flew to Portland, Oregon and met Karsten in person. We were at a conference for people who create online personal finance education. Carsten and I sat down face to face and live streamed the conversation that you're about to hear to my Instagram channel. You can go on Instagram palapant if you want to watch the livestream version of that. But honestly, I think this audio version is better because it's been cleaned up a little bit and enhanced for a better audio experience. With all of that said, let's get to it. Here's former Federal Reserve economist Karsten Jeska. Okay, we are officially live on Instagram and for those of you who are listening via the audio podcast, what you are hearing right now is a live recording. This is Karsten Jeska, otherwise known as Big Earn Earn standing for early retirement. Now, Ern, you, Carsten, are a former economist who is renowned in the retirement planning space. And we keep saying that one day we will do an interview actually about retirement planning and safe withdrawal. But this is not going to be that interview. Can you first of all, please, for the people who don't know you, introduce yourself and then give us a snapshot of our current economic position.
- [02:58]
B
Right. So yeah, I'm Carsten. I'm originally from Germany, but I came to the US for my graduate studies and my first job out of grad school was at the Federal Reserve. So I used to work for the Federal Reserve bank of Atlanta for eight years from 2000 to 2008, then 2008 to 2018, I worked for a big Wall street firm, bank of New York Mellon Asset Management. And even there I was still working in basically an economics capacity. So because we were merging financial decisions with macroeconomic trends. And then even though I'm retired from that, I wouldn't call myself a former economist because once you're an economist, you will always be an economist. You never retire from that. You still follow what's going on. And even on my blog, I sometimes write something about economic conditions and my outlook.
- [03:45]
A
So what is your outlook right now then?
- [03:47]
B
Right, so I mean, in terms of economic growth, we're in this limbo state, right, where it hasn't been particularly strong, hasn't been particularly weak. Right, because we had this weak quarter and the first quarter, but that was really only an adjustment process because everybody was preparing for the tariffs and there was a lot of negative impact from net exports. So there are a lot of imports which would lower GDP growth, at least on paper. And then we had that reversal in the second quarter. So people were a little bit afraid you had a negative GDP growth by minus 0.3% in the first quarter. Or could this turn into a recession? And of course it didn't turn into a recession because there was this adjustment process in the second quarter and that was a more than 3%. And then the third quarter is also shaping up as probably somewhere in that same region, maybe 3%, maybe a little bit below 3% again. So it doesn't look like we are in a recession. There's definitely a little bit of uncertainty over how some of the political changes are going to work out. Tariffs, is that going to put a dent more longer term into GDP growth? Are we going to grow slower because we have less international trade? So people have made that point.
- [04:55]
A
I'VE got a quick follow up to that though. My understanding is that GDP is measured as net exports minus net imports. Would it not make sense then that if we are discouraging imports from coming in and we are encouraging exports to go out, that GDP would technically, based on the way the formula is written, improve?
- [05:16]
B
And that's exactly what say, I mean, this is this mercantilist point of view that we should produce more domestically and we increase GDP that way. And you could make this case all else equal. If nothing else changes, maybe that quarter, you could actually assist your GDP by importing less. But then obviously there's also an economic efficiency loss, right? I mean, there's this whole theory, and it's not just a theory, it's pretty much an accepted fact that comparative advantage, Ricardian economics, that the countries that have an advantage in producing something, they should produce it instead of we trying to make stuff that other countries can do much better, right? I mean, Even in the U.S. yes, we do it with internal trade within the U.S. right. I mean, you don't want to grow citrus fruits in Alaska and you don't want to drill for oil in Florida, right? So you have trade within the United States for the same reason that some places, some locations are better at doing certain things and that we, they should specialize in that and then we trade. So we should also do the same thing on an international basis. So I agree, short term you could manipulate the data a little bit by discouraging imports, but long term, obviously that would be a negative, would be an efficiency loss.
- [06:30]
A
Would that not lead to supply chain, not supply chain disruptions necessarily. I mean, if, if there is nothing disrupting the supply chain, then the supply chain works. But would that not lead to supply chain threats because then another country could threaten to choke off our supply for some valuable resource?
- [06:51]
B
No, absolutely true. Maybe for certain strategically important goods and services, we want to do this domestically, right? So we don't want to outsource our production of aircraft carriers to China, right? Because even though it's more expensive to produce it domestically, just to have the control over certain items, we would insist on producing that ourselves. And then the question is, where's the cutoff, right? I mean, obviously even some parts on the aircraft carrier are probably potentially made in China, right? Maybe not the entire ship will be produced domestically, but basically everything strategically important is produced domestically. I mean, there were obviously some concerns during the pandemic, for example, that certain pharmaceutical items, even just as mundane as ibuprofen and Tylenol, that there were supply chain disruptions in that because that is now outsourced. And then people say, well, is it really a good idea to say maybe to save a half a cent per pill of ibuprofen and ship the production elsewhere if we would face this supply chain disruption next time there is any kind of the global pandemic or any other kind of crisis? And I think even economists will concede that, yes, obviously we are mostly 99% or 90% in favor of free trade and it creates more for everybody. It's a win win for all countries to have free trade and specialization. But there are certain areas where you probably want to keep some strategic control over your food supply. I mean, for example, there are some countries like Switzerland, they insist on being maybe not 100% autark in their food production, but they realized, look, I mean we have been through a lot of wars over the centuries and we don't want to rely on foreign countries because if there is another, and we may not even be part of that conflict, but we prefer to have our own production of a lot of goods and services even if it's more expensive. But we basically prefer to produce domestically even if it is more expensive.
- [08:56]
A
Pulling the conversation away from trade and onto domestic policy. The big thing that I think is on everybody's mind right now is the Fed is meeting. So this audio podcast is going to air on Tuesday. The Fed meets today Tuesday and then Wednesday. Tomorrow is when they're going to make their rate cut announcement. And the futures markets are pricing In a over 90% probability of, of a quarter point rate cut. Do you think that is going to impact our economy or is the impact already priced in based on the futures market certainty? And where are we going from here as a result of that rate cut?
- [09:38]
B
Yeah, so that decision, I think in the bond market it's already fully priced in and it's not just pricing in one single rate cut. Right. It's pricing in a whole sequence of rate cuts. It's actually quite amazing that you said it's 90% chance of a rate cut by 25 basis points. There's actually 0% chance of no cut and then the remaining few percent, which is, and it depends from day to day, sometimes it's of 9%, sometimes it was 6%. That's actually the percentage of a 50 basis point cut. But again the mainstream consensus is that it's a 25 basis point cut, but as you said, it's priced in. And there may actually be a little bit of a disappointment because even though that is Priced in already. And it might be a bit of anticlimactic to look at the statement and listen to the press conference. I think what maybe creates a little bit of nervousness is how are they going to phrase their statement? What kind of a stance will Jerome Powell have in the press conference? Is he going to come out swinging? Is he going to come out very dovish? Is he going to say, yes, we did one rate cut, but don't expect anything more? I mean, that would be terrible news. I think that the bond market, probably stock market too, would get clobbered if that were the case. But because it is really quite stunning and amazing because the last meeting they decided against the rate cut and you had two dissenting members that preferred a rate cut. And now they have not just the rate cut but a whole sequence of rate cuts. And if you look at the futures market, it priced in not just this rate cut, but several more. And now futures markets are actually pricing in six rate cuts, which would take us to the 275 to 300 basis points, the 2.75 to 300 to 3.00. That's much lower than the landing point that we've had even earlier this year. And then basically rate cut hopes fizzled a little bit and then it was basically all priced in all at once over the last few weeks. Basically scared everybody a little bit was the payroll, employment data, not just the one monthly number, but also the revisions. And that definitely caused a little bit of this cascade of not just one rate cut, but several more. And it seems that the market is also pricing in back to back rate cuts for the rest of the year. So one in this meeting, one in the October meeting and one in the December meeting. So that is also definitely new. And that wasn't the case just a few weeks ago.
- [12:07]
A
So for the average person who's listening, how is this going to affect them? Like let's say there's somebody who's listening to this who is a homeowner and they want to sell their home, but they know that it's not a buyer's market right now. They've got some time, they've got some flexibility and they're trying to figure out when is the right time to put my home on the market. Or conversely, maybe there's someone listening to this who's in the opposite boat, they want to buy a home and they're trying to figure out should I go ahead and buy something now or should I wait until January after there have been a sequence of rate cuts first of all, and you and I both know this, but just to establish this for the audience, it isn't the Fed rate cut itself per se that affects mortgage interest rates. It's the ten year Treasury. Can you kind of walk us through how rate cuts impact treasury yields? Both the 10 year as well as the one and two year. That's the first question. And then the second question is what should the average person do with the information that we are likely about to see a sequence of rate cuts?
- [13:06]
B
I mean, first of all, as you said, the Fed doesn't directly target the longer term bonds. Now in some way they did for a while, right? Because they did the purchases of longer term bonds. Now that is not that much of an issue anymore, but strictly speaking. But just setting short term interest rates, well, you just only impact that. But again, at the end of the day you should think of say the 10 year rate as say the average over the short term rates over the next 10 years plus an additional risk premium that you would have for longer term bonds because they will have the duration risk if interest rates move. You could actually either gain or lose quite substantially by holding a long term bond. So you have to be compensated for that. So in some way by moving the short term rates, I mean obviously you should have an impact even on the long term rates through two types of expectations. The expectation would be one, through short term interest rates themselves and then also towards, well, what would happen with bond rates and inflation over the next 10 years. Right. Because that is something that you are exposed as a risk factor if you're a bondholder and if the Fed says that, well, you know, we used to be more afraid about inflation and now we think that inflation, yeah, it's probably still a little bit higher than we would like it, but we already take the foot off the gas a little bit. If you're trying to park a car, right, I mean you're not driving into the parking lot at 60 miles an hour. So you are slowing down already when you see that final resting place. And probably the Fed is doing the same on inflation. Yeah, it is still above 2% but we can already take the foot off the gas a little bit. And obviously so these kinds of expectations, they will also have an impact, probably more so an impact on long term bond yields. If people think that, okay, we have now hopefully once and for all eliminated this inflation shock risk that people had say in 2022 when people thought oh my goodness, could this be a repeat of the 1970s, right? This stagflation, stagflation inflation spiral, wage price inflation spiral. So that possibility has more and more been priced out and the probability went from I don't know, maybe 50% and now it's maybe only a few percent. And then if we eliminate even these last few percent, that could also have an impact on longer term bond yields. So I think, yeah, I mean obviously the Fed will always say we don't have an impact on long term rates, but obviously through multiple channels they still have an impact on, on long term rates. And by the way, they could also could have, how do you want to call it, a very counterproductive impact. For example, if the Fed said that okay, for political reasons we are just going to lower interest rates to 0% overnight, then it might actually increase the 10 year rate. Because then we say, well, I mean in the short term it definitely pulls down interest rates, but in the long term, now we worry again about some kind of an inflation shock where the Fed loses control and credibility. Sometimes it could actually go, and it sounds a little bit like the 3D chess here that you have to think multiple steps and not even 3D chess, just like regular chess, you're thinking multiple moves ahead, that something that may look like goes in your favor in the short term might actually bite you in the behind in the long term. So if the Fed loses credibility and lowers rates, it could actually increase the long term rates because people say that, well, I mean these guys are not in control and there might be some political pressure and this might all become counterproductive and it causes a, a loss of credibility in Fed policy. Basically. There's a lot of math involved in some of this where you say well, how does the short term rate impact long term rates? But I mean some of it almost feels a little bit like art where you have to think well, could this lead to some unpleasant long term effects where you think in terms of first of all like a macro economy, but also almost like a game theorist where you say you're, if the Fed is trying to manage expectations too much, could this also lead to a loss of reputation if they try to micromanage that too much. But again, I think what happens on the Fed decision date is probably already priced in. And then to answer that follow up question, obviously, so what should the average.
- [17:25]
A
American exactly for the average person listening.
- [17:28]
B
To this who's trying to make a.
- [17:29]
A
Decision about buying a home, buying, right.
- [17:31]
B
Buying a home or selling a home or should you refinance? Because obviously mortgage rates have come down a little bit and I would like to use that same phrase Again, that I mentioned last year, there's this phrase, buy the rumors, sell the news, right? So sometimes you have some event where you say, oh, this is going to be really good, say for a stock, right? They're going to release their earnings or they're going to release some announcement that they invented a new product. And then when that news comes out, that's actually the high point of that cycle. And then after that, the rally fizzles a little bit. And it could be be like that too, right, where the bond market has priced in all of these very generous rate cuts. And then I'm a little bit concerned that when Jerome Powell gives the press conference and he might take a little bit more of a hawkish stance, that maybe some of the bond rally that's already been priced in then also fizzles. And if you actually have to time a decision, wouldn't be a bad idea to do it at or around the time when they first announced the sequence of rate cuts. Because who knows? I would almost say, unless the economy totally unravels, I have trouble seeing because obviously what you see in terms of the Fed funds futures rate curve, that should be the average path. So there should be some probability that you are more hawkish or more dovish. To be more dovish than that, I think we would literally have to have a recession. So I can't see how the Fed would be more dovish than what is currently priced into the Fed funds futures curve just because they feel like, okay, now we can lower interest rates and we beat inflation and everything is hunky dory. So it would have to be some event that there is a recession. But I could see ways in which the path would be less stoppish and not as fast and not as deep a landing point. So if you must do something around this, it's probably now a good time to shop around for a mortgage because it could be that once the news is out, people lose a little bit of their optimism there with the future rate cuts.
- [19:38]
A
So buy the rumor, sell the news would mean do it now, because now it's a rumor. Tomorrow Wednesday is going to be the day that it becomes the news. You said when they announce a sequence of rate cuts, but they're unlikely to announce a sequence. They're only going to announce the September decision and the October decision will get announced in October. The December decision will get announced in December.
- [20:02]
B
Yes, and I hope I didn't phrase it that way, but they will announce the rate cut, but they will signal that this is not just one rate Cut. Right. And there will be phrases that are used in the statement that will sound. And then again, just looking back at Federal Reserve history, it's very rare that the Fed just comes out and says, okay, we have a little bit of a concern about the labor market and we are going to lower rates by 25 basis points. Points. And that is the only rate cut far and wide. Right. They haven't cut rates since December last year. They do one rate cut in September and then not do another rate cut after that. I think that that would be a little bit abnormal. I mean, what could be possible is, and this was actually what I had initially thought is that they will say, well, we do one rate cut in September and then they will do the same very slow rate cut pace where they do a rate cut every second meeting. And then especially on the September and December and then March and June, these are the meetings when they come out with the dot chart and their projections, they will time it like that. And then that would be a very slow pace of rate cuts. Right. So you'll do a total of 100 basis points per year. That would have been my forecast if I hadn't checked the futures curves. But yeah, I mean, right now it's even three rate cuts for the rest of the year anyways. They don't want to do a stop and go do one rate cut and then do nothing and then do another rate cut. And so it just creates a lot of volatility and unnecessary volatility and fear in the market. So normally what the Fed does is they don't want to catch anybody completely off guard. So even this rate cut has been broadcast through speeches and comments. And I wouldn't call it leaks. Right. But strong hints. So strong hints. But I would actually call it leaks because definitely when I was at the Fed, I mean, you didn't even have to listen and wait for the statement. You could read basically what the Federal Reserve is thinking about that day by reading the Wall Street Journal. And there's one guy, Greg Ipp, was at that time and he would write an article that morning in the Wall Street Journal and you knew what the Fed decision was and what was talked about at the table. So it's like he was at the table, but he wasn't at the table. So he definitely had some sources. And I think, and I don't know whether this is done intentionally or unint, there's definitely some leakage of information that we're not going to have a decision that completely catches everybody off guard, which is by the way very different from how it used to be. The Fed as a long time ago, they would just do a very terse statement. We lowered rates. And before that they didn't even do the statement. They basically had a meeting and then the market had to figure out after the fact what actually happened at the Fed. And they would see it through the open market transaction eventually. But the Fed has become a lot more transparent and it doesn't want to have anymore this very secretive reputation. And it's very noticeable. So even the latter part of Greenspan, that already started, and definitely under Bernanke, there was a big push to more and more transparency and consensus. Not rocking the boat in that sense. We will know on Wednesday what the decision is. And we probably also have a much better image of what will be the path from then on, even though it's not literally announced, because obviously the Fed has to be data dependent. But we will definitely have the path mapped out conditional on that the economy follows a certain path. And then obviously the rates could be different if the economy falls apart or if the economy does much better or the inflation picks up again, that would then change the path again. So some kind of an unconditional path we will already have.
- [23:54]
A
On Wednesday, you mentioned a push towards Fed consensus. But what we've seen, you know, during the Volcker years, if we really want to take a step in the time machine, during the Volcker years, we saw a lot of Fed descent. And then starting really with Greenspan, you saw kind of a culture of consensus. And now in the last couple of Fed meetings, we're starting to see a culture of dissent again. Do you think the Fed is developing, is moving away from that consensus and moving towards a culture of dissent? A, do you think that is what's happening or not? Or are we reading too much into a couple of dissenting votes? And B, what impact do you think that will have on the Fed?
- [24:35]
B
Culturally, I think there has always been dissent. So the rumor is that there was one meeting where they had a meeting over the phone because it was between Fed meetings. Greenspan was the Fed chairman and they didn't have consensus. And then Greenspan basically said, okay, we're going to hang up for now because we have some technical difficulties and we're going to pick up the phone again in 30 minutes. And after 30 minutes they reconvened the meeting and suddenly everybody was on board.
- [25:03]
A
Wow.
- [25:04]
B
And you know what happened in the 30 minutes in between? Right. So he probably chewed out some people that didn't want to vote the way so yes, obviously the Fed is set up in this way that there's a certain degree of democracy, right? There are 12 voting members, seven governors and five bank presidents. And they all bring their opinion to the table. And they will obviously have different. They all observe the same data, right? But they will obviously explain it and interpret it differently. So, for example, there will be some governors and presidents will say, yeah, I'm still afraid of inflation because unemployment is so low. Because this is, and I've written about this and talked about this many times, I think it's a bit of an antiquated concept. It's a Phillips curve that low unemployment is inflationary, which neither empirically nor theoretically is a really 100% proper way of thinking about the world. And then there are some other people who don't follow these Phillips curve principles. And then just because of that, they all observe the same data, but they will have very different views. What Federal Reserve policy should be where people, for example, should say that, well, I'm afraid about inflation too, but much of the inflation is due to housing. And why is housing inflation so expensive, is so high because interest rates are so high. So we are almost causing the pain that people feel in terms of housing inflation because that is the one rate of inflation where high interest rates, interest rates are actually pushing the cost inflation. Whereas everywhere else you increase interest rates, it cools down the economy, it creates disinflation. Maybe not deflation, but disinflation. But in the housing sector, which is extremely high capital intensity and is usually financed through, well, guess what, mortgages, you create a cost factor. And so you're almost creating the inflation that you're trying to fight. And by the way, we've had the same effect just in the other direction. People in the early 2000s, which is when I was at the Fed and people were scratching their head, well, why is inflation so low? And we're worried about disinflation and deflation and we're keeping the interest rate really low to help create some inflation. And we couldn't really get rid of the disinflation. And the picture was exactly the other way around right there. Now we had the rally in the housing market, right? And if you were a big multifamily lender, you had to give. Basically I was living in Atlanta at that time and I think they were giving something like two or three months free rent if you signed a 12 month lease. And well, guess what? Low interest rates caused a housing rally. Everybody with a pulse could get a mortgage and buy a house and Then what happens to the multifamily renters and landlords? So there was basically cooled down inflation for housing. And so and then the Fed was scratching its head, well, why is inflation so low if our interest rates are so low? And well, that was the exploitation and the same was also true for so for example, used cars were also very had very low inflation. Well, why was the used car inflation so low? Well, because everybody with zero percent interest could just go and get a new car. Why would you want to buy a used car and then also use your home equity line of credit to get that car at a really low rate? And so in some way there are areas of the economy where interest rates are working in the opposite way inflation wise, where actually high inflation rates could be due to high interest rates. Yeah, and I think there are some governors and some bank presidents that understand that and some others that are still holding onto these Phillips curve theories. And so that creates some friction. So we'll see if maybe there could be some dissents now in the other direction where some of the hawkish governors are going to dissent against that rate cut on Wednesday. So we'll see.
- [29:03]
A
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- [29:36]
C
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- [30:12]
A
My favorite season is here. It's fall. The leaves are turning. It's sweater weather. It's cozy. And if you want to make your home a cozier space, Wayfair has everything you need from comfy recliners to warm bedding. They even have espresso makers so you can make a really warm like nutmeg. So cinnamon clove latte at home. So make your space cozy for fall. I've got lots of stuff from Wayfair, tons of shelving because I live in in a Manhattan apartment. It's small square footage. And when square footage is at a premium cubic footage matters. Using the usable wall space matters. So I got a lot of shelving from them in order to make my space more efficient. But whatever you're looking for, I mean if you want warm colors, cozy textures, doormats, things for your bathroom, things to get organized, cozy reading chairs, low lit lamps. There's something for every style and every home. And you get free and easy delivery, even on the big stuff. And you don't have to shop at multiple stores. Everything is all in one place. Cozify your space with Wayfair's curated collection of easy, affordable fall updates. From comfy recliners to cozy bedding and autumn decorations. Find it all for way less@wayfair.com that's W-A-Y-F-A-I-R.com Wayfair Every style, every home the CPI data just came out and inflation has ticked up a little bit, as you'd mentioned. Part of that might be because of high interest rates. You know, high interest rates. And that's actually an important point that I think people don't raise enough that high interest rates do drive housing inflation. But what we've seen with the CPI data that just came out, which they've just reversed, did that contribute to the situation that we're in right now? Is that why we're here?
- [32:11]
B
Well, something caused the Fed to be behind the curve when we had this inflation shock, right? So if you look at any other basically simple models for what the Fed would have done in similar situations in past events, 2021 would have been the time that you would have raised interest rates and you wouldn't have waited all the way until 2022. And I think the I don't want to malign this flexible business there too much, but I think the bigger culprit was that people were throwing around the terms trans transitory versus persistent. And I think there's great confusion about what transitory versus persistent means and because it depends on whether you look at price levels versus price increases. So in some way, every inflation shock is transitory in the sense that, well, eventually we are not going to have 10% year over year inflation and we are now going back down to 2%. So in terms of the rates of change, we had say almost 10% or just around 10%, and now we are at maybe 3% or just below 3%. So in that sense it is transitory in the sense that the rates of increase are back down to the 2%. But where it is obviously very persistent is in the price level. Right. Because if you look at the cpi, the level, it looks like a hockey stick. And then it started flattening again. And we never went down to a lower level again. And by the way, there were some goods and services where you would have gone back down to a normal level. Because there were these stories where during the height of the. Where travel picked up again after the pandemic, and everybody wanted to go to Hawaii and Alaska. And so people went to Hawaii and they were shocked that they had to pay $500 a day for a rental car. And they started renting U Hauls to drive around as their rental car. And then the Hawaiians didn't have enough U Hauls and stuff like that. And I remember I went to Alaska and we rented a car for a week, and the regular rates at the US travel agencies would have been $2,000. And I found one through a German agency.
- [34:31]
A
Wow.
- [34:31]
B
Which was only $1,200. And they wanted to see my German driver's license. So they said if without your German driver's license, because this is a special radius for German tourists, we wouldn't have given you this car. We would have priced twice. Wow. And I was smart enough to bring my German driver's license. So there the price went up. And then after the shock was over, I'm pretty sure I haven't checked any rates for Alaska and Hawaii recently. So definitely even the level is back down again. So there you had definitely only a very transitory inflation, even in the levels. But I mean, you have to admit, in levels, in price levels, the pandemic inflation shock was 100% permanent. We went up to about 10% higher than it would have been otherwise. And we're still up there. And now we are basically going back to a 2% inflation. Right. So I think however you want to measure it, and if you wanted. And then basically they do some kind of a trimmed mean, right. Where they look at the median inflation of all the different categories and they cut out the really high and the really low. So there are all sorts of ways of massaging the data. And yeah, you could argue maybe that contributed a little bit to that confusion. But I think the main confusion that haunted the Fed at that time is this transitory versus permanent. And basically no journalist asked them. So what are you talking about? Are you talking about the level or the changes? That confusion was probably the main culprit. And probably some Fed economists came up with this concept. And I hope he didn't get fired or something over this. So it's not your fault. Okay, so again, transitory versus persistent. Is the or permanent is the bigger culprit there? Okay.
- [36:17]
A
All right, so with all of that said, we have the latest CPI data. Inflation is still running a little too hot, right? So inflation is running a little too hot and yet we're going to start lowering interest rates. What does that mean?
- [36:32]
B
Right, So I mean as I said before, right, if you park a car or say a big container ship comes in, right, they lower the speed already as soon as they can see the pier or the parking lot. So I think it is justifiable in that sense that we have come down from basically almost double digit year over year inflation to so close to the target. So the question is why isn't the interest rate already closer to its long term target? Right. So if you think about we were at the height we have already lowered by 100 basis points to go to maybe a neutral 3% rate, we would have to lower definitely another amount like that and probably a little bit more. So we have only about halfway or less than halfway down the way from the peak to the long term. Whereas inflation has already gone from peak inflation. We're basically 80 or 90% there. So why isn't the interest already 80% or 90%? That could be one response and then the other response is that obviously the economy is looking a little bit shaky, right? So if you look at GDP growth, it's been. And then again we don't want to look at just that one first quarter number. And then by the way, we also don't want to look at only the second quarter number, right, because the 3 point something percent bounce, part of it was bringing some of the negative growth that was basically then realized in the second quarter. But yeah, I mean the economy is definitely expanding a little bit slower and the labor market is again, we've gotten that baseline revision and a relatively weak number in August. And the Fed has a dual mandate, right? It has to monitor inflation and real activity. So by all means, I think there is definitely a case to be made that we want to lower interest rates. And then I mean, you look at some other central banks, they're already way further down on their path, right? I think the Europeans have already lowered by 200 basis points. We have lowered by only 100 basis points. They may face different inflation dynamics and different growth dynamics. It's quite rare that the Fed is so far behind the business cycle and the inflation cycle and GDP cycle. So I have been making the case that The Fed should have lowered interest rates. And then again, I'm not doing this for political reasons because depending on who is in the White House, you can always almost clockwork. This senator will say we have to lower rates now. And then as another person is in power, then that same senator will say, no, we can't lower interest rates now because we're worried about central bank credibility. So I say that no matter who is in office, that the Fed is definitely behind the curve. And it goes back to some of the other points I made earlier about basically housing inflation being the main culprit. And then also the economy looking a little bit shaky. So employment definitely. And then we'll have to see what happens with the shock from tariffs.
- [39:30]
A
What do you make of the major jobs revisions? Employment is not as strong as we thought it was. Based on the initial reports that came out, we actually saw a month of negative job growth. That was June, I believe, which we only just realized as a result of the revisions. Yet we also square that with the fact that unemployment, the unemployment rate is 4.3%. So it's still pretty close to a near historic low. And it's been there for a long time. And many people are describing the labor market as stagnant. Not a lot of people are getting fired or laid off from their jobs, but not a lot of people are getting jobs either. What do you make of the labor market overall and the big revisions that we have recently been seeing?
- [40:18]
B
Yeah, so just like the stock market, the labor market, because it has a growing trend, because the population is growing, it's not so much that the employment level is the problem, it's mostly the rate of change. So, and it could make a difference if, say, instead of growing at 100 to 150,000 jobs a month, it's growing at only, well, say below 50,000amonth. So that definitely feels like a very stagnant labor market. There is a distinction between the unemployment rate and the payroll employment numbers because they come from two separate surveys. And you can have a very low unemployment rate because there might be people who fell out of the labor force because they haven't been looking for a certain time. So we can have very low headline number unemployment rates, but part of that is also due to low labor force participation and then the big revision. So it just goes back to this old issue that. And then again, I was never involved as an economist in this particular area in the data collection part. I was also just an end user for macroeconomic data. And interpreting the end user data is much more Fun and much more exciting. And you can go on podcasts and tell your opinion on that or when I was working. So that was much more exciting. Whereas the nitty gritty detail of putting the data together is an art or craft. And then obviously also science. And the problem is that the payroll employment numbers come from the so called establishment survey. That's where the Bureau of Labor Statistics keeps a sample of. I think it's probably somewhere around 100,000 establishments where they send a survey every month and say, how many jobs do you have? How many have you created? How many have you eliminated? You capture two factors really well with that survey process. You capture job losses and gains at existing firms and then you also capture firms that go out of business, right? So imagine during a recession probably is a certain percentage, or maybe not a percentage. It might be less than a percent of establishments go out of business and then they completely shut down and then they basically go from 800 jobs to 0 jobs. The one thing that you don't capture very well is new establishments. Right? So if new establishments are formed, they will eventually enter the sample. Right? And then, and then the BLS says, oh, you are a new establishment. We didn't even know about you. Oh, and you were formed during the a time when we didn't even know you were there. So can you give us the data of, well, how many jobs did you create over all those months that you were in existence? Oh, wonderful. So now we are going to add some more jobs. And then of course, if the BLS never accounted for that, basically what that would mean is that the real time estimate of jobs created would always be too low because you never capture new entrants and you would constantly, consistently underestimate the job gains. So now what the smart people and the economists and statisticians and mathematicians and maybe accountants and lawyers at the BLS said was, well, you know, we should account for that and we should already budget a little bit of job creation through new establishments. And this effect obviously is most pronounced during economic expansions. During a recession and bear market, you worry mostly about the job cuts and the job exits, the establishment exits, not so much the entrance, but during economic expansions. So the BLS has to make an adjustment. And then the question is, how much of an adjustment do we have to make? Well, we look at, well, how big would have been the adjustment in the past when we didn't make it and we would consistently underestimate job growth. So let's add that to the numbers and then cross our fingers that over time all these new entrants will come in. And it's possible that in this business cycle we didn't have enough and we had less new entrants. And it looks a little bit like, you know, the BLS has some egg on their face over this. Well, so you are telling me that you are just making up and adding stuff to it. So Maybe you added 2 million jobs, but in the end it was only 1 million jobs through new entrants. And now we are missing these 1 million jobs, or 933,000 or whatever was the number over that one year period. And it looks embarrassing, but yeah, I mean, there's obviously some reason to this madness because in the past we would have missed some of these new entrants. And if there are fewer entrants than we had estimated, then this is how you get these big revisions, unfortunately.
- [44:53]
A
Wow. Does that mean, should there be a methodological change as to how those new entrants are estimated? I mean, are there kind of fundamental weaknesses in some of the assumptions underlying that data or was this just a kind of unfortunate run of the last few months?
- [45:09]
B
Well, I mean, the methodological changes should be. Well, how can we find a way to capture these new entrants fast, Faster, Right. Can we find. And again, I'm not involved in this. I've never been involved in this. In fact, I would be misplaced in that job. Right. So my background and training in macroeconomics and finance would not be the best background to work in this capacity. So probably mostly maybe accountants and maybe different fields of economists would be in that field. But you would want to have some faster way of contacting establishments and get a printout of all the EIN numbers out of all the EIN applications of new potential entrants into the job market and tie it to that. But I would say that the statistics behind this is probably okay. This is not like they're going to put their finger in the wind and say, okay, well, we're just going to add 100,000 jobs this month and think that these are the entrants. I think there are some additional mechanisms where they look at other stuff like maybe industrial production or some other data that would help them gauge, well, how many job entrants were there. So it's not just the historical average. It's not just a guess. I'm 100% sure that this entrance data is also estimated in some way, but it's subject to some estimation error and forecast error. Maybe somebody has to go in there and find faster ways of capturing new firms coming into the economy and grabbing them as potential serving members.
- [46:47]
A
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- [47:11]
C
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- [47:42]
A
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- [48:03]
C
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- [48:36]
A
Ask your doctor about ebglis and visit epgliss.lilly.com or call 1-800-LilyRx or 1-800-545-5979. Alright, so we've discussed the CPI data, the series of rate cuts that we are likely about to see descent in the Fed, the culture of dissent in the Fed, the labor market and the jobs report, and the major downward revisions that we've seen and we've talked about how this will affect the average person in terms of buying or selling or refinancing a home. The last thing that I want to ask about, and this is a little bit in the weeds, but you mentioned the dot plot. There are two elements, the dot plot and R. I think these are things that the average person has not yet heard of. Can you lay that out for the people who are listening?
- [49:33]
B
Yeah. So this goes back to this transparency project at the Fed. Everybody who comes to the table at the FOMC meeting. So these would be seven governors and then there will be 12 bank presidents. So we have 12 Federal Reserve Banks in the US of the 12 districts and new York, Boston, all the way Atlanta. I was in the 6th district. The biggest district by area, San Francisco is the 12th district. They all send their Federal Reserve bank presidents to that meeting and everybody gets to talk about their regional situation. But also everybody is going to put in their estimates for important macroeconomic and financial variables. So cpi? Not cpi, it's actually the pce, which is the Personal Consumer Expenditure Price Index, gdp and then also the Fed Funds rate. And then also, I mean not just the path of the Fed funds rate over the next few years, but then also what is the final long term resting spot? Where should we be? By the way, why do they call that R? Why don't they call that the Fed Funds rate in 2029 or something? So the R star basically means that this is the long term Fed funds rate if there are no other economic shocks. Right. If GDP is exactly a trend and the inflation rate is exactly at the target rate, where we would be in this paradisical state where we have zero fluctuations and the Fed could be completely neutral. So that's the R star. And there's a range of different estimates of what that R is, but right now it's about 3%. And then how to get to that R is. So we would also see the estimate of the different voting members. So 19 of them, and again only 12 of them are voting members. Because the Fed bank presidents, they are only rotating except for the New York Fed president, he always votes. And we see the range of estimates for these different variables. And people will very keenly look at what is the, for example, end of the year dot plot for the Fed funds rate. Right. Because that signals to you where the Fed sees the interest rate at the end of the year and it's a pretty good estimate for the Fed Funds rate. I wouldn't quite say that the year out, the end of 2026, what the Fed predicts is the end of 2026. May not be the best forecast. I would probably still go with the Fed funds futures because there are actually some people that put some money behind it and where sometimes with the Fed people make these forecasts and it's not thought to be as a forecast. It's more of where they hope it will be and not where they think it will be. But if we are in September already, I think when we see the dot plot for December, that will definitely signal where people will vote, at least for the next three FOMC meetings. It's a hugely scrutinized output from the Fed. It's a hugely scrutinized data release from the Fed that will definitely cause some anxiety. I think there will be lots of people sitting at their screen at the release date and time and they will click the refresh button and they will look for. And then they want to be the first ones to download that PDF or look at that. I think it's HTML and PDF version that will have some impact on the bond market and on the stock market too, obviously.
- [53:03]
A
And that reminds me of the thing I haven't asked about the bond market. We're seeing treasury yields drop, prices rise, yields drop. As individual investors who have some bond allocations in our portfolio, how should we be thinking about our bond allocations?
- [53:19]
B
It depends on where you are in your life. So I always recommended young investors who are still years away from retirement. You could be 100% stocks. There are some people who say, yeah, well, you should be 90, 10, 10% bonds, 90% stocks. Because that's what, for example, target date funds would recommend. If you're still really young and you have a lot of Runway, I always view your labor income almost like a bond allocation. So the flows that come into your 401 plan every year, they almost feel like a bond allocation. Now, if you work in a highly risky part of the economy, right, where you're a business owner, you're a home developer or something like that, I wouldn't quite call that a bond allocation. But imagine you are a government worker. You can almost guarantee that you're going to have these flows into your 401 plan or thrift plan, which is what it's called for some. You could almost view this as a bond allocation. And the discounted value of all of these future payments is almost like a bond allocation you already have. If you're starting out, you might have several hundred thousand dollars in an implicit bond allocation and zero in a stock allocation. So you should invest very aggressively in stocks. You don't need that much in bonds. When you get closer to retirement, you should have some bond allocation. I definitely recommend right now. I mean with bond yields still pretty decent in the 4% the 30 years actually still slightly above 4% or significantly above 4%, you could definitely have some bonds in your portfolio because you face sequence of return risk. You're afraid that we have a recession right at the beginning of your retirement. And definitely right now it looks as though the next recession is again going to be like one of those recessions we've had 20 years ago and 17 years ago where you had stock market drops. But the Fed also lowers interest rates and that's good for bonds. So bonds are going to be an excellent diversifier. So if you're worried about too much equity risk because you're in retirement or close to retirement, you should consider some bond allocation. And it will vary depending on your specific situation. But it's definitely for very young investors. I have been very aggressive and I actually I was aggressive when maybe I shouldn't have been because I was working in finance. Finance is definitely my pay, paycheck was a little bit correlated with the business cycle too. So my paycheck was a little bit like a stock too. It wasn't a pure bond and even I was still very aggressive while accumulating. So again, yeah, I mean your stock bond allocation absolutely has to change over the life cycle. Start very aggressive towards your retirement, you go more into bonds. And then funny thing is in retirement there are some people, myself included, you can actually go a little bit higher in your bond allocation right around your retirement date just to hedge this risk that you are retiring right at the peak of the stock market. But then you can shift out of bonds a little bit. Think of that almost like a, you could have something like a CD ladder or a TIPS ladder and you phase that out and then you go into a little bit more equity heavy later in retirement and that that actually hedges your sequence of return risk just a little bit. So I think bonds are now quite attractive. I mean, there's some people who say that the expected return in bonds is the relative to expected returns in stocks is quite attractive. So as some people will say, with the extra risk in equities, if you want to become something like a tactical asset allocator, I wouldn't blame you if you're a little bit heavier in bonds. I mean it could pay off quite nicely if you, if bond yields keep going down and say the Fed funds rate goes down to 3% and it stays there long term. That's Definitely going to drag down some of your longer term bond yields and then you have this duration effect. You get your interest. There's a little bit of a roll yield if you have a constant maturity of longer term bonds because you would constantly sell the shorter duration, constantly buy the longer duration and normally what you sell has a little bit lower interest rate. So during the time you hold these bonds, there's a little bit of a walk in the yield. So there's a little bit of a roll yield and that could make up something like 0.3% a year depending on what kind of bond fund you're looking at. So expected returns actually look pretty decent right now as we are recording this. S and P is at or close to the all time high and we have earnings ratios that are insane. Almost as crazy as doing the dot com bubble. So I can see that the bond definitely. You should definitely put bonds on your radar screen if you're anywhere close to retirement or in retirement.
- [58:11]
A
Well, thank you for joining us. Where can people find you if they would like to learn more?
- [58:15]
B
Yeah, I have a blog called earlyretirementnow.com and I'm available there. You can leave a comment there. You can read my blog post. I'm also available on Twitter and the Twitter handle is on my blog. You can go to the contact info there.
- [58:30]
A
Thank you, Karsten, for those insights. Some of you I know saw this on Instagram as a live stream where you saw snippets of it and now we're sharing the full audio with our podcast audience. So whether you caught it live or you're hearing it here for the first time, here are the three biggest takeaways. Key takeaway number one. The Fed's consensus culture is breaking down. This was an interesting insider story that I had never heard. So the Fed has spent decades building a culture where everyone gets on the same page before announcing decisions. Karsten shared a wild story about how consensus used to work behind the scenes.
- [59:13]
B
So the rumor is that there was one meeting where they had a meeting over the phone because it was between Fed meetings. Greenspan was the Fed chairman and they didn't have consensus. And then Greenspan basically said, okay, we're going to hang up for now because we have some technical difficulties and we're going to pick up the phone again in 30 minutes. And after 30 minutes they reconvened the meeting and suddenly everybody was on board. Wow. And you know what happened in the 30 minutes in between? Right. So he probably chewed out some people that didn't want to vote the way that is crazy.
- [59:48]
A
But now the Fed's consensus culture is starting to crack, and the return of dissenting votes might signal much bigger changes in how monetary policy gets made. So that is key takeaway number one, as well as just a really interesting story. Key takeaway number two. High interest rates are actually causing some of the inflation we're fighting. This flips conventional thinking on its head because most people assume that higher interest rates will cool down all prices. After all, when interest rates are higher, it's more expensive for employers to borrow money to grow their businesses. It's more expensive for builders to borrow money to build homes. It's just. It's more expensive to borrow money for growth and expansion. And so the idea is higher interest rates cool the economy, therefore keeping inflation in check. But Carsten points out that higher interest rates also drive up housing costs, which creates a bizarre situation in which the Fed's medicine, the very thing that they're doing to drive down inflation, actually increases inflation in one specific and very important spending category, which is housing.
- [61:04]
B
Why is housing inflation so expensive? It's so high because interest rates are so high. So we are almost causing the pain that people feel in terms of housing inflation, because that is the one rate of inflation where high interest rates are actually pushing the cost, whereas everywhere else you increase interest rates, it cools down the economy. It creates disinflation. Maybe not deflation, but disinflation. But in the housing sector, which is extremely high capital intensity and is usually financed through, well, guess what? Mortgages, you create a cost factor. And so you're almost creating the inflation that you're trying to fight.
- [61:44]
A
And, you know, as I think about this, this works in multiple ways. So not only is it more expensive for retail home buyers for us to be able to buy houses, but given that it's more expensive for builders to build, that has the effect of curtailing housing supply. And we know that the fact that housing is so unaffordable is a direct result of the supply shortage. So on both sides, both in terms of what it costs us as homeowners to purchase a home, as well as the amount of available supply, the amount of new construction on both ends of that higher interest rates drive up home prices and actually create some of the very inflation that we're trying to fight, that is key takeaway number two. Finally, key takeaway number three. The jobs numbers that you're hearing are built on educated guesses. The government just revised job creation numbers, down by nearly a million jobs. And that is one of the biggest revisions in recent history, biggest revision since 2009. And in 2009 we were dealing with the Great Recession when the labor market during the the 2008, 2009 Great Recession was changing very rapidly. There was a massive amount of economic turbulence that led to big revisions in the job numbers in 2009, and we're seeing similar sized revisions now. So while I want to be clear, job numbers get revised up and down all the time. That's very normal. But these massive recent revisions are unusually large. And so the question is why? And Carsten helps shed some light on that. He talks about the inherent challenge of tracking new businesses in real time.
- [63:31]
B
The one thing that you don't capture very well is new establishments. So if new establishments are formed, they will eventually enter the sample. And then the BLS says, oh, you are a new establishment. We didn't even know about you. Oh, and you were formed during a time when we didn't even know you were there. So can you give us the data of, well, how many jobs did you create over all those months, months that you were in existence? Oh, wonderful. So now we are going to add some more jobs.
- [64:01]
A
If there are big changes being made to newly established businesses that could help explain at least a portion of why we're seeing such major revisions. There's a much longer discussion that we could have around labor stat methodology, and that's a different discussion for a different day. But right now the big takeaway is that the jobs numbers that we're hearing are educated guesses built on imperfect data. That's our show for today. Thank you so much for tuning in. If you enjoyed this, if you got value out of it, if you learned something from it, if you were as surprised by that story he told about the inner machinations of the Fed, if you were as surprised by that as I was, please share this with someone. Share it with a friend, with a colleague, with your accountant, your banker, your financial planner. Share it with your mortgage lender or with your favorite Fed watcher. Share this with all the people in your life because that's how you spread the message of FI r e. Please subscribe to our newsletter affordanything.com Newsletter Follow us on Instagram A pant P A U L A P A N t Chat with members of the community affordanything.com community that's the space where you can swap your predictions on what the Fed's gonna do. Or you can talk about retirement planning, debt, home buying, home selling, budgeting, saving. Talk about any financial topic that's on your mind. Again, that's affordanything.comcommunity completely free. Open up your favorite podcast player and make sure you're following this podcast in your favorite podcast playing app so that you don't miss any of our amazing upcoming episodes. And while you're there, please leave us up to a five star review. Thank you again for being an afforder. I'm Paula Pat. This is the Afford Anything podcast and I'll meet you in the next episode.