MacroVoices #550 Harley Bassman: In FED We Trust

Harley Bassman discusses the critical need for the Federal Reserve to restore market trust amid growing skepticism towards government institutions. He argues that recent rate hikes, regardless of their magnitude, will not significantly impact the economy or inflation, suggesting the Fed should have either maintained its current stance or opted for a more substantial increase. Bassman predicts challenges ahead in regaining the Fed's credibility.

He highlights a concerning trend where consumer sentiment is declining even as stock prices rise, indicating a lack of trust in the market. Bassman notes that housing affordability has deteriorated, with the average age of first-time homebuyers increasing from 32-33 to 38 over the past five to six years. He also points out that non-bank entities are disrupting the banking system, complicating the Fed's ability to implement effective monetary policy.

In the context of AI and hyperscalers, Bassman mentions that the debt associated with these entities has surpassed that of the municipal bond market. He believes most hyperscalers will avoid bankruptcy due to their profitable core businesses but warns that the market's preference for monopolies may lead to a few dominant players in the AI sector. He discusses the rising U.S. debt as a percentage of GDP and the implications of a 6% fiscal deficit in a stable economic environment.

Bassman critiques the Consumer Price Index for potentially misrepresenting inflation, suggesting that market signals indicate inflation is not the main driver of rising interest rates. He provides insights into the mortgage market, noting that spreads for mortgage bonds have widened due to increased volatility, currently around 110 basis points over treasuries. He concludes with thoughts on AI's evolving role in trading, suggesting that while AI may enhance strategies, human traders must adapt to remain competitive.

Expressing concern over the trust damage caused by a 6% fiscal deficit, Bassman predicts significant changes to Social Security, including uncapping benefits, raising the retirement age, and implementing means testing. He clarifies that Social Security and Medicare operate on a pay-as-you-go basis rather than as trust funds.

Bassman also notes the proliferation of ETFs, which now outnumber stocks, warning that many high-yield ETFs may involve return of capital, potentially leading to self-liquidating trades. He is skeptical about stablecoins replacing the U.S. dollar due to liquidity issues and believes Bitcoin is unlikely to succeed as a transactional tool compared to traditional payment systems.

Patrick highlights concerns about fiscal credibility and the Federal Reserve's guidance, suggesting these factors could lead to increased volatility in bond markets. He notes that the Fed's recent hawkish stance indicates further tightening may be necessary, with significant recent repricing in rates. Patrick observes that large spec traders are positioning long on short-term bonds while remaining short on long-term bonds.

Bassman discusses the impact of rising crude and diesel prices on inflation expectations and credit markets, predicting that oil price trajectories will influence market triggers. He mentions a decisive upside reversal in the U.S. dollar following the Fed's decision but cautions that one day's movement does not confirm a new trend. He also notes that gold's price movements are closely tied to the dollar's strength and rising real rates, suggesting the gold market may remain range-bound until later in the fourth quarter.

In commodities, Bassman points out that copper's long-term supply constraints remain bullish, although the market is crowded with speculative positioning. He highlights that natural gas speculators are currently net short, with the lowest positioning seen in five years, yet no clear trigger for a short squeeze has emerged. He advises that maintaining short positions in natural gas may require hedging to manage volatility risks.