"The Most Performative Interest Rate Hike Ever"

0:00Welcome to the dividend cafe weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Hello and welcome to the dividend cafe. I am your host David Bonson. I am recording from our beautiful office in Phoenix, Arizona, where I've been for a couple of days with the team here and where we have taken in a Fed week that is the necessary subject of today's dividend cafe. Let me explain something. I really do not want the dividend cafe to be about the Fed every time there's a Fed meeting. It has been more so than normal recently for various reasons and the sort of drama and adventure of having a new Fed chair. But if I were to set it up this way and just simply tell you that I think most Americans want

1:03prices to stabilize. I think most Americans that want to buy a home would like a cheaper mortgage. I think there's some Americans that want to sell a home to get a bigger and better one but don't want to trade a low mortgage for a high mortgage. I think many Americans want the valuation on their stock portfolio to stay high and I think many Americans want groceries to be in a certain price range relative to their own expectations etc etc. Then all of a sudden perhaps this thing seems more, shall we say, relevant to dividend cafe listeners, viewers and readers. But when I talk about it as if it were an academic or macroeconomic exercise, Fed policy, interest rates, quantitative easing, other jargon I could throw on there, it can sound very boring. But when you think of this and the reason I'm writing about it in a very

2:07practical sense and I promise you I'm going to be concluding today with some very practical basic and I would argue relevant takeaways. It changes the tenor a little bit. I'm going to cut to the chase here from the very outset about the Fed's decision to hike rates by a quarter point this week. And I'm unpack all of this and give you a little more meat on the bone but what I primarily want to say is that the Fed in hiking rates a quarter point didn't really do anything much more than acknowledging that they're following the market, not trying to lead the market. The way that the short end of the yield curve, short term interest rates had been going higher, the long end of the yield curve had been going higher when the policy rate was not moving and when the Fed had announced that the last meeting they were not hiking and in fact had not moved rates all year long. What you

3:13really were seeing was the market doing what the market wanted to do not because of the Fed but despite the Fed. And I think this goes completely against the sort of reaction function and the policy, the desired policy function that we've had for quite some time. Markets responding to what the Fed has done, markets responding to what the Fed is going to do, markets responding to what they believe the Fed is going to do, that is all very different than what I think you're seeing now where markets are leading the way and the Fed is following. And it's why I've titled this week's dividend cafe that it was the most performative rate hike. I'm not saying it in a pejorative way and I'm not saying it in a complimentary way but very descriptively, there's not a substance in financial markets

4:14to this rate hike because the financial tightening that a policy rate increase would normally represent the financial tightening has already been done. The financial markets had already moved higher and the Fed is playing ketchup and so I think that this rate hike was intended to be very cosmetic in that regard and that is what it is and I think you need to understand it that way and in a lot of ways you could refer to it as a do over from that December 2025 rate cut, they're kind of taking that cut off of the table and right now seeing a more natural rate somewhere around 3.75 to 4 percent but I will say there's an 87 percent implied probability in the Fed funds futures market of another rate hike by the end of the year. That's about 50 percent for one more, 37 percent for two more. So is there another 25 another 50 coming up into the Fed funds rate?

5:19One or the other is what the market seems to be saying. Now many have asked about the politics of it all. There's been first of all some who said oh the Fed's not independent anymore. They respond with the president bullies them and do and it's kind of an interesting thing. I do not believe that has ever been the case of chairman wash. I've never expected it to be the case. I do not believe when they didn't hike in July at anything to do a president Trump and I do not believe that when they did hike yesterday it had or at this point of your listening Friday I'm recording Thursday that it was relevant that it was an attempt to upset the president. I think that chairman wash is independent. I think that means he can be independently right or independently wrong when he independently takes action or independently doesn't take action. But I do not believe these being bullied by the president. But I've had this little theory for a while. I've shared it with some in my inner circle that the play here was for him if you wanted to be able to hike rates and not upset the president

6:24was to explain that it was providing the president a sort of heads you win and tails I lose scenario meaning the president is going to be okay the way because it gives him a scapegoat. President does like taking credit for good things in economy. I think that's true of all politicians and presidents. I think it's more true of this one. And the president does not like being blamed for things. I think that's also true of all politicians and presidents. And I think it's more true of this one. But there's a sort of optionality that this scenario represents. And so to me it was the way to present it as I think there's a benefit to higher rates. I think it might bring the longer end of the yield curve down. Provides some credibility and independence in perception for the Fed and be used to some regard to match up policy rates with market rates. But to the extent that there are certain things that then drag or lag in the economy you can blame

7:29it on me. And I don't think Chairman Warsh would mind being blamed at all. And so that to me was a messaging that would really be effective. Well I don't know if this conversation ever happened or but what's really interesting is that the president did not blame Chairman Warsh for hiking rates and did not get upset. He said, oh well I told Kevin go ahead and do it because you don't have a choice. Everyone else is doing it anyways and they're politically minded. As if Kevin Warsh, the chairman of the Fed had to do it even though he didn't want to. And I don't even know what to say because I honestly do not know the answer nor do the people I know what do I expect that they would tell me the truth as to whether or not the president really believes that. Chairman Warsh clearly wanted to do this and clearly said so. And so where that came from is a little mysterious to me. But then the president did something that I think is probably a little more

8:30clever than people are giving him credit for it. I didn't think so at first. But in individend cafes, no matter what we'll put up on the screen right now, the actual cut and paste of the president's true social post, where what he said was that interest rates should be one percent or less. He's saying, oh yeah, rates really should be lower. And this then you think is where he would normally go to say, why is my central bank person hiking rates and they should be cutting? And he goes on to say it's because we have such a great economy and great credit. And then this is the part that's fascinating. If we stop training every country of deficit with, we would make $1.5 trillion a year. The deficit is a fanciel word for was referring to trade deficits, referring to the amount of trading with other countries, lower interest rates for America fast. So he confuses credit spreads that reflect the credit worthiness of the country with the actual interest rate. And then goes on to talk about trade deficits, there's nothing to do with this at all. And some folks thought, you know, this is pretty scary. The president is mixing up like two or

9:32three different things here. I think the president is completely wrong about what he's saying, regarding trade deficits that you lose money when you buy something from someone else. I just, I don't, I kind of do think he really believes that, but I have written time and time again about the errors of that mentality. But my point of bringing it up is that what the president did here might even be, you know, on purpose to just simply divert the attention away from what the fed did, and go into a couple different red herrings that are actually not connected. And it becomes this sort of non-critical criticism. Like, yes, he is saying rates should be lower, but then he's going on to talk about trade deficits that have nothing to do with the fed decision. And it seems to me, it's almost like a effective way to move it and not defend his chairman, but not criticize the chairman. And I'm not one of these people that always thinks the president is putting 4D chess.

10:33And I'm also not one who thinks he's always being dumb. I think that sometimes he's right, sometimes he's wrong, but like in this case, I think you're, those trying to assess the politics of it, I promise you, there were media, character yesterday, just begging for a soap opera between the president and the chairman. And I think what you saw was kind of this interesting way of not giving them what they wanted. So whether or not my scapegoat theory is going to play out, we will see, but nevertheless, the political side of it did not go to where many thought it would. And now, if you think the fed is going to raise rates one more time this year, I do suspect they won't do it at the late October meeting, being one week before the midterms that they would wait to the December meeting. It's entirely possible. They do one in October and not one in December. It's possible, they do one in each, but I would imagine they won't. Now, the midterm thing is absurd. There's just absolutely no reason not to. If you think it's the best thing to do, the fact that it's six days

11:33before the midterm, like some person's going to say, I was going to vote this way for my congressman, because of a rate hike six days ago, I just don't, I don't believe it. And yet, those that would say, oh, there's this appearance of political meddling. I think we say there's an appearance of political meddling to make there be an appearance of political meddling when there is no appearance of political meddling, but that's beside the point, whether or not they will, I suppose, is probably unlikely in October. And then we'll see in December, the table has been set for one more rate hike. What is their reasoning? Well, let me first point out that they got a 12-0 vote. And that's very important. It was nine, three, not to hike at the last meeting. It was 12-0, two hike at this meeting. And so the unanimous collegial consensus is important. I don't have a source on this. I'm speculating. I believe there were one, if not two, Fed governors, the voted against a rate hike and changed their vote to allow for the unanimous consensus once they saw the way the

12:37vote was going. I would need to suspect that of Fed governor Waller and perhaps one other. But again, I don't know that. But either way, it avoids more drama within the Federal Public Committee and the Fed governors. And that's a healthy thing. But I also think his comments in the press conference chairman Warsha's speak to their general frame of mind. They think the jobs picture is good. They being the overall economy is good. And that then took the pressure off the other end of their dual mandate to focus on the price stability and what they said in July was that there was upward pressure on prices, but they acknowledged a supply shock. And they took that language about supply shock out. Now, someone in the press conference said a quarter point rate hike isn't going to reopen the straight of our moves. And that's certainly true. But what I think that they believe with some data behind this for sure is that yes, the the straight of our

13:38moves being closed and the various Middle East geopolitical elements are really not in the Fed per view. And by the way, there's other supply shock issues, I think, terrifulated that are not in the Fed's per view either. But that there's enough upward price pressure and markets have voted that they believe that they need to focus on the price stability component with the policy tool they have available, which is the Fed funds rate. Now, they're paying 3.9% to banks to hold reserves at the Fed. They're paying on those excess reserves and interest rate of 3.9. That's right in the middle of the Fed funds rate, which is between now 3.75 and 4. So they're not trying to dramatically incentivize or disincentivize lending one way or the other. As long as the amount they're paying is within the Fed funds rate, it doesn't either tighten or expand lending really at all. It's a very neutral and shall we say performative monetary policy step.

14:46How did the bond market react? Well, in the immediate aftermath, you saw the two year jump up quite a bit. The 10 year moved up about five base points, but it had been down five base points before. So you saw further flattening of the yield curve that the short end was up more than the long end. As I'm talking here middle of the day, Thursday, the entire yield curve is down about five basis points, but evenly so. I think the 10 year was now down about six basis points. So look, a 30 year at 5.3% right now, a 10 year at 4.94, there's no big performative flex in the bond market on any of this. It is directionally has moved where you might expect to to, but mortgage rates are back to 7%. And that's what's going to matter more than anything else. Is the 10 year going to get back to 4.5 where you could actually see it start to pull mortgage lower probably not anytime soon. But the one thing I do want to say and it's an insanely difficult dance for the Fed as they're trying to use a higher long end to bring, excuse me, a higher

15:55short end to bring the long end lower that markets very rarely will respond exactly as you want. And the markets are leading as I've pointed out right now when it comes to monetary distortions and interventions, all you really can do is get lucky or do damage, see things you don't want to happen. It's very hard to pull off desired policy aims without the trade offs that you're trying to avoid. Now, I'm going to put a chart up real quick that you could argue as a positive element of the last day or so. This is the 10 year tip spread, the inflation break even and you can see it's dropped about five basis points. Okay, so at the 10 year drop five basis points and the tip spreads are down five, that means that you brought rates down a tiny bit without expectations of lower real growth. That's what they want. Now, it's been 24 hours and it's only five basis points,

16:58but directionally, that's what you would like is to be able to increase rates and believe that you are dampening inflation expectations without impacting real growth or hiring or productivity in the economy. The question about what all this means to the stock market, I first want to point out, I say it over and over again, I cannot say it enough. Looking at the first 45 minutes or hour and a half after the Fed does anything at any Fed meeting day is a fool's errand. It is filled with traders, speculators, hedgers having to cover and rebuy or resell or whatnot from where they were in a very short expectation. You get very heightened volatility. I went back to the last 10 Fed meetings. You see an average move in this very limited period of time of 83 basis points peak to trough in a 30, 60 minute window. You going back 24 Fed meetings, you get three times

18:00the normal volatility in a regular hour, 90 minute period of time. Do I believe that the Fed funds rate matters to equity evaluations? Well, first of all, in theory, we know a bond yields and the risk-free rate are a factor. However, they just simply haven't been for some period time. That doesn't mean they're not a factor. It means markets investors have been for now looking through it. Mathematically, in the annals of corporate finance, we know what it is, but I wouldn't have guessed you could have a 4% Fed funds rate, a 4.5% two year, a 5% 10 year, and maintain a 23 times multiple in the S&P, but we've done it for quite a while. Do I think that higher bond yields eventually put downward pressure on equity evaluations? I mean, we know they do academically and theoretically. But what I would say is that trying to speculate on that or the timing of that,

19:01when you have earnings growth, the AI business model, oil prices, market valuations are all far more important factors than the Fed funds rate, will they won't they talk from the Fed in terms of the status stock markets? Let me close with this. Yes, the Fed is raised at quarter point. No, it doesn't matter to the extent that financial markets had already done it. Yes, mortgage rates have been higher in the last couple of months. And yes, those borrowing money then are theoretically paying more. That includes governments and it includes commercial real estate developers and it includes residential mortgage borrowers. But just please remember that every dollar that's ever been borrowed is a dollar that was lent. That for every debtor, there's a creditor, for every spender, there's a saver, and that one person's interest expense in the P&L is another person's

20:04interest income in the P&L. And to the extent we think that a lot of times that's banks, that's fine, but also remember there are widows, retirees, savers that now have more interest income that they're going to be spending. I am really of the mindset that I, nor you, President, nor a central banker should be trying to pick favorites between the borrower and the lender, the saver and the spender, the creditor, the debtor. But these things are just part of organic healthy market activity. And to the extent we still continue to require the Fed to set the prices for how those parties transact, which does effectively ask them to create a favorite in those transactions, I think it's problematic. Now, I know it's not going away anytime soon.

21:07And I've said that repeatedly, but to the extent that the Fed is allowing markets to set rates and they play catch up versus them trying to impact market rates, I take that as a baby step victory. That's where we are this week, a performative rate hike and an awful lot of room to go, but a lot of other bigger and more important questions for those trying to actually understand the economy and where risk assets will go. More important questions than the never-ending drama around the Fed. If I could say all this to President of the United States, I would, and in the meantime, I'll settle for my wonderful listeners, readers and viewers of the dividend cafe, have a wonderful weekend. The Bonson Group is a group of investment professionals registered with high-tower securities LLC, member Finra and SIPC, and with high-tower advisors LLC, a registered investment advisor with the SEC. Securities are offered through high-tower securities LLC, advisory services are offered through high-tower advisors LLC. This is not an offer to buy

22:08ourselves securities, no investment processes for your risk. There's no guarantee that the investment process or investment opportunities reference to your end will be profitable. Pass performance is not indicative of current or future performance and is not a guarantee. The investment opportunities reference to your end may not be suitable for all investors. All data and information reference to your end are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary and does not constitute investment advice. The Bonson Group and high-tower shall not, in any way, be liable for claims and make no expressed or implied, representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or emissions from the obtained data and information reference to your end. The data and information are provided as of the date reference, such data and information are subject to change without notice. This document was created for informational purposes only that opinions expressed are solely those of the Bonson Group and do not represent those of high-tower advisors LLC or any of its affiliates. High-tower advisors do not provide tax or legal advice.

23:11This material was not intended or written to be used or presented to any entity as tax advisor tax information. Tax laws vary based on the client's individual circumstances and can change at any time without notice. Clients are urged to consult their tax or legal advisor for any related questions.