Real Vision Podcast: Episode #1002 - "Are Higher Rates Here to Stay?" with Bob Elliott

Release Date: March 26, 2024

Introduction to the Discussion

In episode #1002 of the Real Vision Podcast titled "Are Higher Rates Here to Stay?", host Maggie welcomes back Bob Elliott, Founder and CEO/CIO of Unlimited Funds. The primary focus of their conversation centers around the current trajectory of interest rates in the U.S. economy, the implications for inflation, the labor market, and the broader financial landscape.

Current State of the U.S. Economy

Maggie opens the discussion by highlighting recent economic indicators:

• Stock Market Behavior: Despite expectations of a stock rebound, most indexes closed lower except the Russell, which showed resilience.
• Treasury Yields: Slight declines were observed.
• Economic Data: Stronger than anticipated durable goods orders contrasted with a dip in consumer confidence.
• Upcoming Indicators: Anticipation of the Personal Consumption Expenditures (PCE) reading.

Maggie remarks at [01:19]:
"Where do you think the US Economy is?"

Bob Elliott responds at [01:55]:
"The economy moves slower than expectations. We're seeing modest deceleration with some data softening, particularly after the strong second half of last year."

Inflation Dynamics and Energy Prices

A significant portion of the discussion delves into the complexities of inflation:

• Energy Prices: Initially, gas prices dropping from $5 to $3 provided a disinflationary effect. However, recent rebounds in oil and gasoline prices are raising concerns about sustained inflation.

  Maggie shares a personal anecdote at [03:09]:
  "Inflation is real. The smallest cup of yogurt ever for $7 in New York City is shocking."

• Disinflation vs. Inflation: While durable goods saw a decline in prices due to resolved supply chain issues, the services sector remains sticky, maintaining elevated inflation levels.

  Bob Elliott elaborates at [03:59]:
  "Durable goods disinflation flipping to inflation, coupled with slow-moving services inflation, challenges the Fed's ability to bring inflation below 2%."

Wage Growth and Its Impact on Inflation

The conversation shifts to wage dynamics:

• Wage Inflation: Elevated nominal wages, especially among lower to middle-income cohorts, contribute directly to inflation. The relationship between wages and productivity is crucial in understanding inflationary pressures.

  Bob Elliott states at [06:02]:
  "Nominal wages continue to grow, particularly in high propensity to spend income cohorts. The key is whether productivity growth can offset this wage growth."

• Productivity Concerns: While there has been a recent uptick in productivity, questions remain about its sustainability amidst rising input costs like gasoline prices.

Federal Reserve's Monetary Policy and Interest Rates

A central theme is the Federal Reserve's (Fed) approach to managing interest rates:

• Rate Cuts Speculation: Initially, the market anticipated multiple rate cuts. However, current data suggests that fewer cuts, if any, are likely.

  Maggie queries at [08:20]:
  "Does the Fed's plan to cut rates three times seem doable against this backdrop?"

  Bob Elliott responds at [08:43]:
  "Market adjustments now price in 2-3 cuts, but given the data, fewer cuts or none are more probable."

• Neutral Interest Rate: Elliott discusses the concept of a neutral interest rate likely higher than the post-2008 Financial Crisis era, suggesting rates closer to 3.5-4% or even 5%.

  At [15:59], Bob Elliott explains:
  "The baseline level of interest rates is likely higher than 2.5%, possibly around 4-5%, due to factors like higher demand for capital and persistent inflation."

Implications for Bond and Stock Markets

The potential shift to higher interest rates has profound effects on various financial assets:

• Bond Markets: A rise in long-term rates would negatively impact bondholders who are locked into lower rates, altering valuation models and potentially leading to decreased bond prices.

  Maggie observes at [16:38]:
  "Higher neutral rates are bad for bondholders and could upend valuations, affecting the entire financial system."

• Stock Markets: Increased discount rates could lead to declines in stock valuations. However, Elliott believes the real economy could withstand the pressure from higher rates without a significant derailment.

  At [18:54], Maggie summarizes:
  "The real economy can tolerate higher rates, but the financial economy, particularly assets sensitive to interest rates, cannot."

Commercial Real Estate (CRE) and Banking Sector Resilience

The discussion touches upon the resilience of the commercial real estate sector and the banking industry's ability to manage potential stresses:

• Commercial Real Estate: Despite higher interest rates, banks have demonstrated adeptness in managing CRE exposures through loan restructuring and regulatory relief.

  Maggie notes at [28:34]:
  "Banks are experienced in dealing with bad loans, and CRE issues are being methodically managed without threatening the broader financial system."

Global Central Banks and Comparative Monetary Policies

Bob Elliott provides insights into the actions of other central banks, particularly the European Central Bank (ECB):

• European Central Bank (ECB): The ECB appears more hawkish, yet recent wage data (3.1%) suggests they may act more aggressively than the Fed in managing inflation.

  At [33:19], Maggie explains:
  "The ECB might move faster in tightening due to softer growth and lower wage increases compared to the U.S."

• Bank of Japan (BOJ): Elliott speculates that the BOJ is likely to maintain its current easing stance for the foreseeable future.

Investment Opportunities Amid Higher Rates

Concluding the discussion, Maggie asks Elliott about current investment opportunities in a rising rate environment:

• Yield Curve Steepener: Elliott suggests that positioning for a steepening yield curve could be advantageous, offering risk-reward benefits and tail risk protection.

  Bob Elliott advises at [34:25]:
  "A yield curve steepener is an attractive bet, providing protection against unexpected market shocks."

• U.S. Dollar: The dollar remains compelling due to the robust U.S. economy and comparatively dovish stances of other central banks.

  Elliott adds:
  "The dollar is strong, especially against currencies of regions where central banks are easing."

Conclusion and Key Takeaways

• Higher Interest Rates: The consensus leans towards sustained higher interest rates, potentially around 4-5%, diverging from the previous 15-year norm of 2-2.5%.

• Inflation Management: Persistent inflation, especially in the services sector and wage growth, challenges the Fed's ability to lower rates, necessitating a reevaluation of monetary policy strategies.

• Financial Market Implications: Higher rates pose risks to bondholders and could recalibrate stock valuations, although the real economy may remain resilient.

• Global Dynamics: Other central banks, notably the ECB, may adopt more aggressive tightening measures based on their unique economic indicators.

• Investment Strategies: Emphasizing yield curve steepeners and leveraging a strong U.S. dollar present viable opportunities in the current financial climate.

Notable Quote:

At [36:52], Elliott underscores the importance of being a rate strategist:
"The bonds are also in the credit, and the bonds are in the loans, and the bonds are in everything. The bonds are in the houses. Everyone has to be a rate strategist because it matters so much."

This episode provides a comprehensive analysis of the current economic indicators, the Federal Reserve's potential policy directions, and the broader implications for various asset classes. Bob Elliott offers a nuanced perspective on navigating the complexities of higher interest rates, emphasizing the importance of strategic positioning in an evolving financial landscape.