Did The Fed Just Back Down? | Joseph Wang & Michael Ippolito

Episode Summary

Executive Summary: The discussion centered on the Fed’s June “hawkish pause,” with Powell holding rates at 5.25% while signaling two more hikes via the dot plot. Joseph Wang argued the Fed is likely to keep tightening because inflation and labor market easing have been slower than expected, while balance-sheet runoff and bank credit tightening remain important crosscurrents. The episode also covered housing, reserves, commercial real estate, fiscal deficits, and why markets may be underpricing persistent inflation.

Main Topics: Fed's hawkish pause and dot plot signal (Priority: 5/5): Powell skipped a hike in June but the committee lifted its year-end rate projections, signaling that the pause is temporary and additional hikes are likely. Why the Fed paused instead of hiking immediately (Priority: 5/5): The hosts debated whether Powell is waiting to assess lagged effects of prior tightening, while still using guidance and higher market yields to do some of the tightening work. Inflation, wages, productivity, and the labor market (Priority: 5/5): Wang argued inflation remains sticky because wage growth is still elevated and productivity is soft, making labor costs inflationary even as headline CPI improves. Balance sheet, reserves, and reverse repo mechanics (Priority: 4/5): The conversation examined how Treasury issuance, money market demand, and the reverse repo facility affect reserve scarcity and the Fed’s implementation of policy. Bank credit, commercial real estate, and recession risk (Priority: 4/5): Participants discussed slowing bank lending, office CRE stress, and whether credit tightening will ultimately trigger a recession, likely later rather than immediately. Markets, assets, and the reverse wealth effect (Priority: 4/5): They debated why stocks have rallied despite restrictive policy, with Wang emphasizing psychology, fiscal support, and lingering market faith in buying the dip. Global central banks and China (Priority: 3/5): The discussion broadened to foreign central banks, especially China’s easing stance, and whether global liquidity shifts matter for U.S. inflation and asset prices.

Key Arguments: The June meeting was as hawkish as a pause can be because the Fed raised its projected year-end policy rate to 5.6%, implying two additional 25 bp hikes. Powell’s framework suggests the Fed can slow the pace of tightening while still moving to a higher terminal rate and holding there longer. Market pricing has repeatedly underestimated the Fed over the past two years, so futures odds of July or September hikes may be too dovish. Inflation remains more persistent than expected across the Western world, suggesting a structural rather than purely transitory problem. Wage growth around 6% plus declining productivity keeps unit labor costs elevated and supports ongoing inflation. Headline inflation may be easing, but the Fed focuses on core PCE, and it likely will not feel comfortable until core PCE trends clearly below 4%. Balance-sheet runoff can continue because excess reserves and the reverse repo facility still provide cushioning, especially if Treasury shifts issuance toward short-dated bills that money funds will buy. Regional bank credit tightening is real but lagged; it is likely to hit growth more meaningfully next year than this year. Commercial real estate stress is concentrated in office exposure and mostly at smaller banks, while G-SIBs and large regionals have comparatively limited exposure. Asset prices matter for monetary transmission: if stocks and housing rise despite higher rates, the reverse wealth effect is weakened and policy is less restrictive than intended.

Data Points: Fed funds target range: 5.00%–5.25% - The policy range was left unchanged after the June FOMC meeting. Upper bound of Fed funds range: 5.25% - Current upper end of the target range discussed during the episode. Year-end median dot plot: 5.6% - June dot plot median implied two additional 25 bp hikes by year-end. March year-end median dot plot: 5.1% - March projection used as comparison for the hawkish upward shift. Implied increase in year-end policy path: +50 bps - The Fed’s median year-end rate projection rose by 50 basis points versus March. Market odds of July hike: ~60% - Jack cited CME pricing showing a majority probability of another hike in July. Probability of no July hike: ~40% - CME pricing cited on-air for staying at current levels in July. Wage growth: ~6% YoY - Wang said U.S. wages had been growing around this pace for about a year. Atlanta wage tracker: 7% to 6%+ range - Used to show nominal wage growth is easing, but slowly. Headline inflation (May): 4.1% YoY - Discussed as evidence that headline CPI is moving lower due in part to energy disinflation. Core inflation: Stickier than headline - Core measures were described as falling more slowly than headline CPI. Banking sector loans in 2022: ~$1.2 trillion - Wang cited a record year of credit creation, far above normal lending volumes. Normal annual bank lending: ~$4 billion - Wang contrasted last year’s lending boom with a typical annual figure from the transcript. Fiscal deficit: ~7% of GDP - Used repeatedly as a major source of ongoing demand support. Commercial real estate exposure: G-SIBs: ~$100 billion - Fed analysis suggested large global systemically important banks had limited exposure to at-risk CRE. Commercial real estate exposure: large regionals: ~$100 billion - Fed analysis suggested large regional banks also had relatively limited exposure. Commercial real estate exposure: small banks: ~$500 billion - Smaller banks were said to hold the bulk of at-risk CRE exposure. Treasury reverse repo rate: 5.05% - Discussed as the floor/implementation tool tied to the Fed’s policy band. Fed lower bound: 5.00% - Used to explain why the reverse repo rate cannot be cut materially below the target floor. Fed operating/interest burden concern: 2% mortgage assets vs 5% RRP liabilities - Illustrated how the Fed is paying more on liabilities than it earns on some assets.

Pivotal Quotes: "This was as hawkish as it could be for a pause." — Joseph Wang: Wang’s opening characterization of the June FOMC meeting. "It’s about the speed, not versus the level and how we get there." — Jay Powell (as paraphrased in the discussion): Used to explain why the Fed paused while still signaling more hikes. "If you buy a gym membership in January... at what point do you say, go to the gym?" — Mike Ippolito: Analogy criticizing the logic of pausing when the Fed still expects more hikes later.

Implications: Listeners should expect higher-for-longer policy, with more volatility in rates, tighter credit ahead, and continued pressure on rate-sensitive sectors. The key risk is that inflation proves stickier than markets expect, forcing further Fed tightening into late 2023 or beyond.