The Fed Holds Rates Steady | Bond Market Revolts

0:00 Hey everyone, thanks for dropping back into the macroverse. Today, we're going to talk about how the Federal Reserve held interest rates at 3.75% and the implications of that on the bond market and risk assets. If you guys like the content, make sure you subscribe to the channel, give the video a thumbs up, and also check out the sale on Into the Cryptoverse Premium at intothecryptoverse.com. If you do enjoy these more macro discussions about how it's affecting investing in different asset classes, I think you would like coming to the first ITC conference taking place in Miami on November 20th through the 22nd. So, make sure you guys check that out. Link is in the description below.

0:43 We're going to be raising those prices in a few weeks, so make sure you guys get your ticket in the meantime. Let's go ahead and jump in. So, we just did a video yesterday saying that the Fed was unlikely to hike rates in July. Now, there were some banks thinking that it might actually happen, but you know, the the markets didn't think it was going to happen. They said about a 2/3 chance they would hold constant, and in fact, they did. And what we said was what made the most amount of sense from that ties everything in to like the business cycle and a potential correction coming by the S&P 500, which normally happens in the back half of midterm years, and then a future market cycle bottom by Bitcoin, how it all ties together.

1:25 And what we said was it would make the most amount of sense if you need a narrative, not that you need one, but if you require a narrative, the narrative is just simply the Fed doesn't cut or they don't Sorry, they don't raise rates at the July meeting. And because they don't raise rates, the bond market starts to revolt. And sure enough, look at the 30-year yield today.

1:55 The 30-year yield has been trying to get through 5.2% for years, right? Ever since really October 2023 when it hit that level. And now the Fed was unwilling to raise rates. And what happened is the bond vigilantes are revolting. And they're saying, "No, we used to be more worried about inflation than the labor market." Now, I know what some of you guys are thinking, right?

2:29 Oh, inflation's not an issue. Why why worry about inflation? But there's a lot There's a reality here of There's just a lot of uncertainty about inflation, right? I mean, yes, oil has come down, which is a good thing, right? I mean, oil has dropped a lot, but look at you know, look at XLE. This is something that I I've talked about for a while. Look at this thing. And look at how I mean, it it wasn't even that far away from a new high just a just yesterday, basically 2 days ago.

3:01 There's a lot of uncertainty in you know, in the energy markets. And normally, from a business cycle perspective, energy is one of the last things to top. Right? And we haven't even had the IPOs by OpenAI, etc. So, you would thought that sort of is like this future thing. So, I I I think as it you know, as we think about Sorry, I need to make this Hold on a second. Sorry about that.

3:31 wow, I'm going to get a lot of complaints about that. The video my video being large. when you think about it, right? This all makes sense. The Fed doesn't hike. The bond vigilantes revolt. And they're like, "Oh, >> >> you no way, right? Oh, hell no. You you you can't get away with this. The 30-year yield breaks out. The 10-year yield What did we say the 10-year yield would do? That it would head back to where it was in October 2023. It's on its way.

4:07 That TLT we go sweep the lows from October of 2023 and guess where it's headed? To those lows. It all makes sense. And so, what I what I could see happening is if the labor market data still comes in strong. And I know people like, "Well, the labor market isn't that strong." I kind of agree with you in some sense. Like, they're not hiring. There's not a lot of hiring. There's not a lot of job openings. But, the reality is there's also not a lot of layoffs.

4:39 If there were a lot of layoffs, initial claims wouldn't be so low. I mean, the last time initial claims were at like 187,000 was what? Like, five decades ago or something? Yes, it can change quickly. But, the problem for the Fed is that you have a labor market that is heating up in the sense that you're not really seeing layoffs. The unemployment rate has been coming back down. And one of the reasons that inflation was starting to get tackled was because wage inflation was coming down.

5:13 But, if the labor market starts to tighten back up, that could lead to fears about wage inflation going back up, which could then lead to headline inflation going back up. Yes, it pulled back. So what, right? I mean, it's not like we've never seen a spike before where inflation didn't pull back before going higher. like, I mean, look at look at this over here in the '70s. It spiked up to 7%, came back down to 6.2, and then still ran to 14. So, this time we've spiked up to 4.1 and we back we drop back down to 3 and 1/2.

5:55 You know, you have to wonder is the Fed should are should they have raised rates today? And if you look at the two-year yield, then I think absolutely they probably should have raised rates today. But, while they should have, we still put out the video yesterday, this video right here, saying they wouldn't, right? Saying they likely wouldn't. And what what and this actually is is key to look at this. Look at the probability of a rate hike or the probability that rates would be at 4% by September.

6:36 Or let's say that the probably they won't be at 4%. Only 23% chance. Now that we had this press release, now that we had the press conference by Kevin Warsh, where is it now? It was 23% chance that the Fed would still be at 3.75 by that September meeting. Now, by the September meeting, almost a 43% chance they'll still be at three three and point 75%.

7:11 So, it's not just that they didn't hike rates, but now market participants are not as sure that they're going to hike rates in September. So, what and and Kevin Warsh even talked about He said that rates were going up, right? Long end was going up. It is. And if if the bond market thinks that the Fed isn't going to get a handle on this thing and if they're not going to hike rates, there's only one direction for the for yields to go, and it's up.

7:43 They have to go somewhere. They're either going to trend up or down. They trend down more so when when there's fears in the economy and and and you think and markets think that we're, you know, too tight. But right now that's not the case. And you might say, well, why do they need to raise rates? What's really changed? The neutral rate is arguably what changed. Now, the neutral rate is an abstract concept, right? Like it's not there's not like a clear definition of of like what the neutral rate even is.

8:21 You know, is it 3%? Is it 2%? Is it 4? Is it 5? Good luck finding a consensus on that. But I think, as well as many others, I think that one of the best approximations we have for the neutral rate is the two-year yield. In fact, for modern portfolio theory and calculating out the Sharpe ratio or the Sortino ratio, a lot of times people might use the two-year yield as the risk-free rate.

8:54 So, when you look at the two-year yield, back in March, the two-year yield was at 3.4%. So, when you have rates at 3.75%, that's theoretically restrictive because it's higher than the neutral rate. The idea is that when the Fed funds rate is higher than the neutral rate, the the market start the economy starts to contract. When the Fed funds rate is lower than the neutral rate, the economy starts to expand. So, you could argue that back over here in early 2026, let me overlay interest rates on the here. We'll we'll put this on the the scale.

9:36 You could argue that back over here we were not restrictive. Or sorry, no. You could argue that we were restrictive. My mistake. You could argue that we were restrictive because the two-year yield was below the Fed funds rate. So, restrictive. But, look. That's not the case anymore. The two-year yield went up, thereby meaning the neutral rate has theoretically gone up if you believe that the two-year yield is a good approximation of it. And if the two-year yield is an approximation of the neutral rate, then the Fed funds rate is no longer restrictive.

10:24 It's actually more accommodative than it was a few months ago, even though rates did not change. So, remember, the neutral rate is a moving target. And if you look if you zoom out throughout history, the Fed chases the two-year yield. Look at this. The Fed chases the two-year yield. The two-year yield tells the Fed what to do. Fed does not tell the two-year yield what to do. The market tells the Fed. And you can see there's plenty of times where the two-year yield goes up and it takes a while for the Fed to get the memo. But, look.

11:02 The two-year yield overtook the Fed funds rate back in March. It's taken them a while to get the memo. I think they're going to get the memo. I would argue September is a likely time for them to raise rates. I'm not 100% confident about it, but if you made me pick a month, if you just said what is the highest likelihood month if we're going to get a rate hike this year, what is the most likely month it's going to be?

11:31 September could be it. I mean October could as well, but probably one of the next 3 months, right? Like I I I think there will be a rate hike in 2026. It's just a matter of what month is it going to be? Is it going to be September, October, or December? And there's a lot of people that think that they won't raise rates before the midterms, but I would say they they could. A lot of people thought they wouldn't cut rates for the midterms and they still before the presidential election in 2024 and they still did. And they say, "Well, this is different because why would they raise rates?"

12:02 you know, why would the administration theoretically be okay with that? Well, theoretically they are not intertwined, even though that's obviously debatable. But more importantly, right? And this is is sort of the more important aspect of it, is that you could argue that a rate hike wouldn't be nearly as much damaging as inflation coming back and people realizing the Fed's not going to do anything to stop it. What would the incumbents prefer? Would they prefer to be seen fighting inflation?

12:35 Or would they prefer to be seen letting inflation run rampant? Remember, the two major things that lead to incumbents losing are inflation coming you know, inflation surging and recessions. Think about it, the last two presidential elections were lost because of those two issues, arguably. Biden lost after an inflationary wave. Trump lost the election before after a recession. Yes, it was due to a pandemic. I'm not going to pretend like the pandemic was was Trump's fault, right? I mean it it was going to happen regardless of who was in office, but the markets don't care. If you have a recession near the election, the incumbent often loses. If inflation is an issue near the election, the incumbent often loses.

13:21 So, you could argue that refusing to raise rates might actually be more damaging than raising them. Because what's going to happen in the midterms if inflation's coming back and people realize, "Whoa, the powers that that are in office right now aren't going to do anything to stop it." So, they want to vote them out because no one likes inflation. So, it's a really interesting time in markets. I I'm fairly confident I could be wrong. I'm fairly confident they will raise rates once and I think it's going to correspond to this like 10 to 20% drop in stocks that I think is going to happen. Remember, three midterm years, 2014, 2018, 2022, every midterm year for the last three, the market dropped 10 to 20%.

14:15 Near the end of 2014, right, sorry. Yeah. Let me go to the weekly. So, if you look at at the end of 2014, over here, 10%. End of 2018, 20%. End of 2022, 20%. They started in the August to September time frame. There was another time the market dropped about 10% and that was in from starting in July of 2023 into October of 2023. Guess what that corresponded to.

14:50 Pause the video and guess. What did the drop in late 20 It started in July 2023. What did it correspond to? You got it. Well, at least I hope you did. It was the 10-year yield going crazy. So, what this means is if the 10-year yield is about to go up again and the 30-year yield's already breaking out, then yields are headed higher. And wouldn't it be interesting if the 30-year if the 10-year yield started going up and tops in October, which is exactly when it found that top in 2023, guess what else October has in common? Potentially a market cycle bottom for Bitcoin. I mean, I guess I'm not saying you need a narrative, but the narrative is there. And I don't know what people are going to blame later this year, but it's all there on the charts, okay? It's all there.

15:49 We'll see if it's right, but I think that all this makes the most amount of sense and and we talked about this yesterday. We've been talking about it forever. The Fed's unwilling to raise rates, the bond market revolts, yields go higher, the market corrects. When the market corrects, it makes people realize they're not going to raise rates forever, right? They're not raising rates back up to 5 and 1/2% more than likely anytime soon. And then cooler heads prevail and then hopefully the market can start doing well again, you know, going into 2027. So, the narrative is there if you need one, but you really really do not need one. If you guys like the content, make sure you subscribe to the channel, give the video a thumbs up. And again, check out the Investing Through the Cycles Conference taking place in Miami November 20th through the 22nd. Make sure you guys get a ticket. I look forward to seeing you guys there.

16:41 Thank you for tuning in. I will see you next time. Bye.