Concerns about tightening credit conditions and slowing growth are fueling speculation about what the U.S. Federal Reserve’s next move might be. James Dixon, Director of Family Office Solutions at TD Securities, says he expects a significant shift in the Fed’s policy strategy.
Greg Bonnell: Investors are weighing the odds that the US Federal Reserve will be on pause after last week’s rate hike. But our feature guest today says we may see a more significant shift in the Fed’s strategy going forward. Joining us now with more, James Dixon, Director of Family Office Solutions with TD Securities. Great to have you back on the show.
James Dixon: Thanks for having me, Greg. It’s lovely to be back.
Greg Bonnell: Let’s talk about what’s happening with the Fed. Last week, everyone wanted to read the tea leaves and said, OK, we may actually be on a pause after last week. You think perhaps even more significant policy changes in the months to come?
James Dixon: I do. Last week, to be honest with you, I thought it was a policy mistake. The last time I was on the show–
Greg Bonnell: The hike itself being a mistake?
James Dixon: That’s correct. The last time I was on the show, I communicated pretty clearly that I thought the Fed was done. That seemed to be the communique. Slowly, more and more got priced in. The Fed hiked 25%– well, 25 basis points. Again, we have dovish communique.
What I thought was really interesting is Powell comes out and he talks about stability for banks, you know, them being in good shape. And I think this is quite troubling. I thought this was really a bit of lip service.
And the reason I say that is, we still have the commercial real estate problem that we talked about the last time I was on the show. We’ve still got a problem with deposit flights. And we still have a big mismatch between assets and liabilities on per-maturity transformation policies.
So I mean, the real question is, what now? We’ve got slowing growth. We’ve got very tight credit conditions. On my team, we still believe there’s going to be a big Fed pivot. And as I talked about the last time I was on the show, there’s a limit to how much they can do in terms of rate policy. I think the more significant shift is actually going to come in the form of bond purchases.
Greg Bonnell: So we’d be back to quantitative easing in short order, you think? I mean, that would be– that’s a big difference between saying maybe we pause after this and see how it transpires to getting back to rate cuts, which maybe the bond market thinks they’ll be doing by this summer, and then actually buying of bonds.
James Dixon: Correct. So we’re actually on our own in this camp. That’s certainly not our house view. We think that this pivot is coming because there is a wall of maturities coming due over the next couple of years. It’s over $9 trillion. So the problem is, who buys this debt? So the Fed– if the Fed doesn’t buy it, I don’t know where the issuance is going to go.
So the Treasury issues new bonds to soak up the old debt, make the repayments, and put more debt on the books. But on that sort of size investment, I’m not sure how the market absorbs it. You don’t have the same buyers that you had the last time around because you’ve got this Cold War with China. And the US weaponized the dollar when they froze dollar-denominated assets, which isolates a lot of previous buyers.
So even if investors went and soaked up that full issuance, what happens to credit spreads? You’ll see the yields on those corporate bonds go through the roof, which is going to make funding incredibly difficult and kill any growth prospects.
Greg Bonnell: What would the market do with that information? Because obviously, you get the sense that there are certain market participants that want to see a Fed pivot. They want to see them get out of restrictive territory in terms of their rate policy. And then they follow that thinking through thinking, this would be constructive for equities. Is it that simple, over the kind of situation you’re laying out?
James Dixon: Well, 100%. So if the Fed does come and buy all these bonds, this is a huge amount of liquidity injected into the market. It’s very bad risk. It means a weaker US dollar. It means equities will rally. I mean, the problem is it’s also inflationary.
So where it could get a little choppy is you might have an announcement of a bond-buying program that sort of spikes inflation and then they’ve got to taper back on that. So it could lead to quite choppy markets.
Greg Bonnell: Inflation– let’s talk about that situation. Obviously, headline has been coming down for several months now. And of course, the thinking is that just to get it back to where you want– around that 2%– is the tougher game. Is this something they can achieve?
James Dixon: Well, I think we spoke about this the last time I was on the show, Greg. We do believe inflation is sticky. Some of the bigger themes are out there– reshoring of supply chains, remilitarization, building of critical infrastructure at home, commodities prices remaining elevated. We think these are all inflationary. We also think the problem with demographics is a big issue, and this will play out.
So while we think inflation pushes lower, we do think we settle around that 3%, 4% mark. And what’s really quite interesting is when we first came out with that thesis, that was over a year ago. And my team and I– no one bought into that narrative. And that seems to be almost the Street narrative now– sticky inflation prints, it pushes lower, eventually settles around 3%, 4%. And that’s going to curb Fed policy.
Greg Bonnell: This term got thrown around, I think, near the beginning of the big spike we saw in inflation, when people stopped talking about transitory and started thinking we had a bigger problem on our hands. The central banks react. Some people will throw out the term “stagflation.” and there’s a generation that doesn’t really know what that means– to live through that. Is that a concern going forward?
James Dixon: 100%. So I think that if you take a step back, an economy can really be in one of four phases. So you’ve got inflation going higher and growth going higher. You’ve got inflation going higher and growth stagnant– the stagflationary environment. You’ve got inflation going lower and high growth. Or you’ve got inflation going lower and growth going lower.
So the stagflationary environment is a real problem because what do you do? You have to ease to spur growth. But it’s tough because inflation is elevated. So what do you do? And this is– if I allude back to what we talked about on the last show, I think it’s almost an environment where central banks have to become comfortable with higher inflation rates. And that’s because balance sheets have ballooned. And if you have a ballooned balance sheet, the only way to erode your debt is to inflate it away.
Greg Bonnell: If they had to become more comfortable with a higher rate of inflation– say for argument’s sake, it was 3%, whether it was 4%, and they’re saying that’s fine. We don’t have to get back down to 2%, is that an official policy move they have to make? Or is that’s just something that they would sort of say, well, you know, de facto we’re cool here even though we haven’t changed our overall target.
James Dixon: I think that’s a tricky one. You could make the same argument about the debt ceiling. The debt ceiling is raised continuously, but has there ever been a policy change? And the answer is no. So I think you have a similar scenario here where we de facto settle around these rates. They can’t come out and openly say, we’re changing policy, because I think it would be politically highly unpalatable.
Read the full article here