Why Raising Rates Would Actually Calm Markets | Jim Bianco

Jim Bianco argues that the Federal Reserve's forward guidance policy has created two distinct failure modes. The first forces the Fed into wrong policy, as seen when repeated insistence that post-pandemic inflation was transitory prevented timely rate hikes until inflation reached 8.6 percent in 2022. The second causes market disruption when the Fed deviates from its signals, as in the 2013 taper tantrum when Bernanke's pivot caused the 10-year yield to rise 140 basis points in four months. Silicon Valley Bank is cited as a concrete moral hazard example, having leveraged heavily into long bonds without a hedge after relying on Fed signals that rates would not rise.

The episode's central counterintuitive claim is that raising rates would calm bond markets rather than disrupt them. The Fed cut rates six times for a total of 175 basis points starting September 18, 2024, yet the 10-year yield is approximately 95 basis points higher and the 30-year yield approximately 1.25 percent higher than they were at that starting point. The 30-year yield stood at 5.2 percent at recording, near a 19-year high. Bianco says across 55 years of data there is no other example of the Fed cutting this much for this long while long-term rates rose simultaneously. By contrast, when the Fed aggressively hiked in 2022 against roughly 9 percent inflation, long-term rates settled because the bond market no longer had to price in unaddressed inflation risk. His conclusion is that bond traders can stop panicking when the Fed starts panicking, and that a credible rate hike signal would likely bring long-term yields down and reduce systemic risk for equity investors as well.

Kevin Warsh refused to submit a dot to the Fed dot plot and wants to eliminate forward guidance entirely, offering a reaction function instead. He has indicated inflation data matters more to him than employment data and has dismissed the monthly payroll report as only accurate on its third revision, which arrives 18 months later. A task force under Warsh is developing more real-time employment measures. The Fed is currently in a messy regime transition, with three members voting to hike at the July 29th meeting, Lisa Cook signaling readiness to raise rates, and Bianco predicting Chris Waller might add a fifth voice favoring a hike before the September 16th meeting. Market odds of a September hike were approximately 40 to 50 percent at recording. Bianco predicted most future Fed meetings will show hiking or cutting probabilities between 33 and 66 percent rather than the near-certain outcomes markets had grown accustomed to.

Inflation has been above 2 percent for 64 consecutive months, currently running at approximately 3.4 percent, compared to only about three or four months above 2 percent during the entire decade from 2010 to 2020. Bianco argues that if inflation is running at 3 to 4 percent, interest rates should arguably be in the 5 to 6 percent range. Meaningful balance sheet reduction as an inflation-fighting tool is not viable in the near term because Dodd-Frank regulations left overnight repo and SOFR funding markets too small relative to federal debt, and the Fed has compensated by providing daily market funding through its large balance sheet. In September 2019, an attempt to reduce the balance sheet caused the repo rate to spike to 9 percent. Structural changes require coordination between Treasury Secretary Bessent and Warsh, and Bianco estimates meaningful balance sheet reduction may not be viable until the second half of 2027 or 2028.

AI capital expenditure is the only AI economic effect Bianco asserts with confidence. Alphabet Google's capital expenditure this year is approximately 190 billion dollars, exceeding Russia's spending on the Ukraine war, and all hyperscalers combined are spending approximately 1.2 trillion dollars, exceeding the US Defense Department budget. AI-related stocks including semiconductors, capital equipment, and the MAG7 represent approximately 45 to 50 percent of S&P 500 capitalization across roughly 50 stocks. Bianco warns the eventual crash could be as large as or larger than the 2000 dot-com bubble given that concentration, but places the current cycle closer to 1997 or 1998 than to the 2000 peak, suggesting significant upside may remain before the correction arrives. He agrees with Warsh that AI will eventually produce disinflation but does not expect it before approximately 2030, and cautions that bond investors will sell bonds if asked to price in future AI disinflation while near-term inflation remains elevated.

Bianco contends there is no persistent dollar debasement trade, arguing gold's rise around Liberation Day reflected fears that Trump's tariffs weakened the dollar, and that the subsequent Iran conflict drove investors back into the dollar and reversed that move. On Bitcoin, he argues the crypto community made a strategic error by shifting focus from building an alternative financial ecosystem toward attracting traditional wealth management allocations through products like the IBIT ETF, a rally that worked temporarily and then reversed. He views the Genius Act and Clarity Act as the wrong approach because requiring regulatory permission from Washington undermines the decentralized and permissionless qualities that give crypto its core value.