Moneybeat: Hitting the gas, riding the brakes

JENNY ROUGH, HOST: Coming up next on The World and Everything in It … the Monday Moneybeat.

NICK EICHER, HOST: It’s time to talk business, markets, and the economy with financial analyst and adviser David Bahnsen.

He’s head of the wealth management firm The Bahnsen Group and he’s here now.

David, good morning!

DAVID BAHNSEN: Good morning!

NICK EICHER: All right, David. Here’s the chairman of the federal reserve last week.

POWELL: Today, the Federal Open Market Committee decided to reduce the degree of policy restraint by lowering our policy interest rate by a half percentage point. Inflation is now much closer to our objective and we have gained greater confidence that inflation is moving sustainably toward 2 percent.

NICK EICHER: So let’s start at the top and just kind of drill down through it—hit the key points—but certainly a momentous decision cutting those 50 basis points, dropping the target interest rate a half of a percent.

DAVID BAHNSEN: Yeah, there're a few things that are momentous here. I mean, just in the sense that it's the first cut of rates in 54 months. The last time the interest rate had been cut was in March 2020, when the Covid moment was taking place. It's the first change in interest rates since July of 2023, so about 14-15 months ago. And of course, that last change was a hike. So to have that long a period of time, well over 400 days where there was no change at all, what we would call a pause, is very unique. And now to start with a 50 basis-point cut, to really telegraph that they want to get it down 100 by the end of the year—but then another 100-plus change next year. The issue that I wrote about over the weekend in Dividend Café is, this is the first time in my adult life that the two policy tools the Fed has are pulling in different directions. During the financial crisis, Ben Bernanke famously started using something called quantitative easing, and it was meant to be an additional policy tool, to either be easier in monetary policy, looser, or to be tighter by the Fed buying bonds with money that didn't exist. Okay? And so when interest rates were low and lower, they were doing quantitative easing. When interest rates were high and higher, they were doing quantitative tightening. Right now they're lowering rates, but they're doing quantitative tightening. So you have two policy tools pulling in opposite directions. I don't believe that's sustainable, and that's, to me, the big issue as to what they're going to end up doing. If they were really that worried about the economy that they were lowering rates, why would they also be continuing to tighten with their balance sheet? I believe that they desperately need to get the short-term interest rate lower, which is why they're lowering, but they don't want to see the long term rate come lower—and the reason is the long-term growth expectations are just too low.

NICK EICHER: So interesting. And I think it’s important for the listener who wants to sit with this a little more and understand better, I’ll post a link to your Dividend Cafe column, and we’ll have it embedded in the program transcript.

But just to pursue this a little further, David, I think anyone who follows this even casually knows about the fed’s setting of market interest rates by its own policy rate.

But that other tool, quantitative easing or tightening relating to the fed’s buying, holding, or rolling off government bonds. Would you walk through how that second policy tool works and why it’s considered a policy tool?

DAVID BAHNSEN: So if you're a central bank and you believe that you can use the cost of capital and various monetary conditions—money supply, liquidity—to affect economic activity, what do you do if you're trying to stimulate and you're already at 0 percent? That's the question Bernanke faced in October of 2008 going into 2009: We're at zero - what do we do? And what they decided to do was further stimulate, by the Fed using its balance sheet to buy treasury bonds and mortgage bonds from banks. So there's more cash on the balance sheet of the banks, and it's an asset for the Fed. So now the Fed owns this bond. 

And your question to me, Nick is, How is that a policy tool? It's adding liquidity into the banking system, and then if they're buying enough bonds, the Fed can use it as a tool to manipulate the interest rate. You know, if they want the 10-year bond yield to be lower, they can go buy a bunch. If they want it to be higher, they can sell a bunch, right? That's what it means. Is it's an additive tool, for when you run out of efficacy from the main tool you're using, which is the interest rate. And you're right: People understand the interest rate and the media talks about it. The other tool is a little less understandable, but the media doesn't understand it either, Nick. But I would say the central bank doesn't fully understand it in the sense that you can't understand something that's never been done before. So when you do something experimental, you're kind of going by trial and error.

NICK EICHER: So on the one hand, we’ve got the interest rate coming down, which is stimulative of the economy short term, while doing quantitative tightening. That has the effect of pulling the reins long-term. What’s the point of that?

DAVID BAHNSEN: Yeah, so here's the issue: You cannot go lower the short-term rate from 5-1/2 percent to 2 percent overnight. You destroy central bank credibility. It would create panic everywhere. People would say, What in the world is wrong that they're doing this dramatic cut? However, right now, the 90 day T-bill is 4.7 percent, and the 10-year treasury is 3.6. Well, why does that matter? Because it points to something broken. You want a higher level of interest to loan money for 10 years. So what is the problem? Growth expectations. And I recognize for listeners that there's a lot of jargon here, and it's complicated, but I really believe this is important stuff, because it gets to something finally that I've been talking to you about on The World and Everything in It for years, which is that the excessive amount of government debt has put downward pressure on long-term growth—you would not have a 10-year bond yield at 3.6 percent. That basically means that people are expecting about 1.5 percent real GDP growth, okay? This is less than half of our historical average.

NICK EICHER: And let me stop you on that. Knowing the historical average for economic growth, or what we’ve considered good, normal economic growth, is 3 percent or a little better. Do you think, then, that what’s happening now could be the beginning of a monetary policy reckoning around the issue no presidential candidate or member of Congress is willing to tackle—and that is slow-growth, high-debt?

DAVID BAHNSEN: Well, first of all, we've been in slow-growth, high-debt for 15 years. So it is absolutely not the beginning of it, but it's a new iteration of policymakers dealing with it. But the only reason why I hesitate to answer your question the way I think you want me to is because I don't think they're going to hold that. I think that the two policy tools are going to be on the same side of the field again. And more than likely, it'll be quantitative tightening, reverting to either quantitative easing or just a neutral position. You know, to their credit, the balance sheet of the Fed got up to $9 trillion during Covid. They've gotten it down to $7 trillion. And I've said for a year or so now, if someone told me that they were going to take $2 trillion of financial-system liquidity out of the economy, and that there would be no spike in unemployment, no decline in GDP, no collapse in the stock market, I wouldn't have believed it. And they've done it. But are they going to get another $2 trillion out? No, they are not. There is a there's a reckoning in that sense, yeah.

NICK EICHER: Ok, David Bahnsen is founder, managing partner, and chief investment officer of The Bahnsen Group.

Check out David’s latest book Full Time: Work and the Meaning of Life at fulltimebook.com.

Have a great week, David!

DAVID BAHNSEN: Thank you, Nick.

WORLD Radio transcripts are created on a rush deadline. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative record of WORLD Radio programming is the audio record.