Hawks Take Flight | Joseph Wang on Fed’s Hawkish Hike and Warsh’s Gameplan

Joseph Wang asserts that the Federal Reserve's recent interest rate hike was anticipated, driven by signals from the Jackson Hole speech. He describes the meeting as hawkish, indicating it could mark the beginning of a new hiking cycle, with at least two more hikes expected. Wang emphasizes that the Fed's current policy remains insufficient to achieve the 2% inflation target, and he notes that the decisions are dynamic, leaving room for adjustments.

Wang highlights the influence of geopolitical events, particularly in the Middle East, on the Fed's inflation outlook, alongside a current unemployment rate of approximately 4.1%. He points out that the medium dot for 2028 has risen from 3.4% to 3.9%, reflecting a shift towards a higher for longer stance on interest rates. This suggests a fundamental reassessment of the neutral rate, which is now perceived to be higher than previously estimated.

Wang claims that inflation is being driven by a commodity bull market, which complicates the traditional central bank approach of overlooking supply shocks. He believes the market is currently experiencing a significant equity bubble, which historically leads to Fed rate cuts and a shift towards long bonds. The appeal of long bonds is heightened by historically high real yields, contingent on the Fed's ability to manage inflation effectively.

In discussing the housing market, Wang notes its deterioration due to elevated mortgage rates but predicts a future decrease in these rates, which could spur a stock market recovery. He acknowledges the stickiness of house prices, making them resistant to decline. The market is currently pricing in a maximum of three hikes over the next year, while Treasury buyback operations are aimed at enhancing liquidity rather than manipulating yields.

Max Weethy comments on the recent Fed meeting, describing it as the most significant of Kevin Warsh's tenure, which led to notable market reactions. He observes that the market's movements were larger than usual due to uncertainty surrounding the nature of the hike, with the raising of target rates for the next two years being a major surprise. Weethy also notes that refining stocks have emerged as the standout trade of the year, outperforming semiconductors.

Wang discusses the strong performance of the oil refining sector, which has achieved a total return of 73%, outpacing the semiconductor industry's 45.2%. He anticipates quarterly earnings could reach between $7 to $8 billion, primarily driven by the refining segment, which is currently generating $5 billion in profit. The price of West Texas Intermediate (WTI) oil has surpassed $100, raising concerns that current charts may underestimate processing volumes.

Wang highlights China's recent activity in the oil market, noting that the country has been hoarding refined products and is now actively purchasing oil. The lack of strategic reserves of refined products contributes to the high crack spreads observed in the market. He identifies Marathon Petroleum as the leading refining company, projecting an EBITDA of $9.4 billion, though he expresses skepticism about the accuracy of this estimate.

The discussion also addresses the implications of high diesel prices, currently at $6, which could have significant repercussions across various sectors. Despite these elevated prices, there is uncertainty regarding potential demand destruction. Wang emphasizes the critical role of diesel in global industries and notes that agricultural commodities remain profitable.

In the semiconductor sector, Wang believes that earnings estimates for Lam Research are too low, anticipating substantial revenue growth for the company. The conversation also touches on the potential impact of ongoing geopolitical conflicts, particularly in Iran, on commodity markets. Wang argues that estimates for AI-related investments are significantly understated, suggesting a figure of $10.5 billion instead of $9.6 billion.

The Atlanta Fed's nowcast indicates a GDP growth of 5.1%, while concerns are raised about the implications of higher short-term rates on AI development. The discussion concludes with differing views on the significance of the yield curve and the potential regulatory impacts on the AI trade, highlighting the complexities and uncertainties in the current economic landscape.