Moneybeat: The Goldilocks Fed

MARY REICHARD, HOST: Coming up next on The World and Everything in It: The Monday Moneybeat.

NICK EICHER, HOST: It is time now to talk business, markets, and the economy with financial analyst and advisor David Bahnsen, head of the wealth management firm, the Bahnsen Group. David is here now. David, good morning to you.

DAVID BAHNSEN, GUEST: Well, good morning, Nick, good to be with you.

EICHER: Well, David, I have got a full docket here. But just to make sure that we cover all of the news, what do you see as the big story coming out of last week?

BAHNSEN: I don’t think that there was any single economic story that was a standout last week. The earning season is going to really kick in next week and the week thereafter, so the next two weeks are much more substantial in terms of the relevance of earnings results and hearing what’s been going on at these large companies: hiring plans, firing plans, revenue, growth, profitability, margins, the impact of costs. These things are all a big deal.

When we focus so much on federal policy, I think we forget that what happens in the day to day economy—what’s happening within the businesses that we work at and patronize—is much more foundationally important. So earnings season is about to become our big focus.

EICHER: Right, right. So any early indications of how that's going to go?

BAHNSEN: We’ve had one week of results so far, and it was fairly positive. I wouldn’t say it was better than expected or worse than expected on the whole, but it was better than expected for the big banks. Now remember, a lot of the damage from the Silicon Valley Bank closure was contained in the last three weeks of March, and companies are reporting for the whole first quarter. But I think what we saw so far within the banking results was a little better than expected.

I can certainly tell you this: We are not in a recession right now. No question.

EICHER: All right. Well, speaking of banks and the Fed, the Wall Street Journal had a big story over the weekend, saying that the Fed, the Federal Reserve, is considering, as the Journal puts it, "closing a loophole that allows some midsize banks effectively to mask losses on securities they hold, a contributing factor in the collapse of Silicon Valley Bank." The journal goes on to describe an exemption that allows some banks to boost the amount of capital they report for regulatory purposes. It has to do with so called unrealized losses on certain securities the banks hold against deposits. The story says regulators are weighing the change after the sudden collapses last month of SVB and Signature Bank rattled the financial system. If adopted, it would reverse a loosening of rules by the Fed in 2019, and heighten oversight of mid-sized banks by extending restrictions that currently apply only to the largest, most complex firms. David, what do you think about that potential move by the Fed?

BAHNSEN: Oh, I think it’s ridiculous. And I think it’s totally unhelpful and unnecessary, done for no other purpose than to have people like us say that they did it. It’s purely cosmetic. There is no restriction that allows a bank to pretend that they have a value they don’t have.

Right now, when you have a bond that will mature for $100 in 10 years, if you were to sell it in the market today it will be worth $92. The reason the banks have it marked at $100 is because they’re marked in a hold to maturity in their balance sheet, and it is most certainly worth $100 in hold to maturity. The footnotes and other things that people doing financial analysis are supposed to be looking at indicate that difference in that their liquidity was less, because if they were to sell hold to maturity assets (which, by definition, are not supposed to have to be sold) then yes, they’d be taking less. But that was all known. That was all reported.

The problem was not the knowledge or the reporting. The problem was they ended up having to sell assets you weren’t supposed to have to sell. So the issue the Fed is trying to tackle here is totally cosmetic. It implies to some people that there was something wrong before about the reporting when there was not. What was wrong before was that they did not hedge interest rate risk: That they had a ton of deposits that were hot and that there was a concentration of a certain type of banking customer that led to more volatility in their deposit base. But the fact that they had long dated bonds that were absolutely money good will lead it to cut the other way, because you’re going to end up having bonds that were bought to mature at $100 that will go up in value. Now is that going to help?

Anybody can see that those bonds are worth 108, which for 27 of the last 28 years of my adult life were trading at premiums to par value, not discounts. So for one year, all of a sudden, we’re in a discount to par. And while it’s going to be helpful to see the number up or down above par value, that is not the number they get back in maturity. The whole thing is ridiculous.

EICHER: Well, David, last one, I want to call a special attention to your Dividend Cafe column this past weekend. Very interesting story about the Fed and inflation. It covers a lot of the ground that we've covered over months and years really kind of compresses it in. And there's this moment in the column where you're talking with a friend about how the Fed has been on the exact wrong end of things during COVID, and in the post-COVID environment, in short, that the Fed's monetary policy was too loose in 2020, and '21, and too tight now. So talk about what led you to that insight.

BAHNSEN: Well, I've been making the point here on The World and Everything in It, and in my own writing, and speaking for quite some time, that right now, the inflation data is not accurate to the real-time reality on the street, because nobody in their right mind thinks that rents and house prices are inflating in the present tense 8 or 9%. And yet, for example, the month of March CPI assumes an 8.2% input of annual inflation growth into the cost of rent and housing, when I think it is likely a negative number, -1, -2%, we're happy to pretend it's 0%. And certainly, no matter what soaking wet, it isn't more than +1% or +2%. Yet, because of the way that they measure shelter in inflation data, it has a huge lag effect. They're looking at numbers that can be one or two years old that are feeding into the methodology and all avoid the details and complexity of how they do that for our purposes.

I had dinner with a really close friend of mine by the name of John Mauldin, who's a very well known investment newsletter writer in our industry, and he had asked if I feel so strongly about that, which I do now, what I thought was happening in 2021. In other words, when interest rates are at 0%, when inflation was showing much lower, but we all knew that housing prices were actually skyrocketing higher, was the same lag affected then, hurting, but the other way, and I emphatically said yes, and most certainly was. Now, of course, we have a really hard time talking about inflation in our country, because people seem incapable of doing it, apart from political agendas. Where economically, where I don't have a strong political agenda, I do believe that the goods inflation from when the supply chain was broken, is different than the housing inflation from when the Fed had rates at 0%. And so I prefer nuance and detail and sometimes a more granular analysis, that's gonna be I think, more accurate, but it doesn't make for good sound bites, it's probably not even good on our podcast right now. But that's how I have to do things to be an honest, you know, analyst and economist.

The inflation inputs were underreporting reality two years ago, they're over-reporting it now. And everybody knows it. And so you say, Well, why didn't the Fed respond? Because I don't believe the Fed's real impetus has ever been about the inflation. There's other aspects of trying to control the business cycle. And yet, they have to do so behind their congressionally mandated duty of price stability. So in '21, they could hide behind the low inflation data to justify staying too low, too loose, too easy for too long. And right now they can hide behind inflation data to justify why they continue hiking rates when, clearly, they've already tightened financial conditions and, clearly, we do not have an excess demand problem. Prices have come down substantially and are continuing to come down. And if we weren't over counting shelter prices, we have inflation somewhere between two and 2.8% now, so the fact of the matter is that we just simply have the same problem that cut in two different directions.

EICHER: All right, well, you may have a question for David and if you do, you can send it to feedback@worldandeverything.com. We have come to the end of our time for today. Always comes too quickly. David Bahnsen is founder, managing partner and chief investment officer of the Bahnsen Group. His personal website is bahnsen.com. But I do want to call your specific attention to that Dividend Cafe column that is very much worth a read and you can find that at dividendcafe.com. I'll have a direct link to it in today's program transcript. All right, David, thank you and have a great week.

BAHNSEN: Thanks so much, Nick.

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