Has the Fed Abandoned Risk Assets? | Joseph Wang

Episode Summary

Executive Summary: This episode analyzes the January FOMC meeting as a distinctly hawkish pivot: Powell signaled inflation is worse, rate hikes could begin in March, and even 50 bps was not ruled out. The hosts argue the Fed is repricing markets, tightening financial conditions via forward guidance, and preparing balance sheet runoff in a way designed to avoid market dislocation while still pushing rates higher.

Main Topics: FOMC meeting read-through (Priority: 5/5): The hosts interpret the 2:00 statement as expected but the 2:30 press conference as a hawkish signal that March rate hikes are effectively on the table and that the Fed is no longer downplaying inflation risks. Inflation versus recession risk (Priority: 5/5): Powell is framed as saying inflation has likely worsened since December, making price stability the dominant concern over recession fears, especially with a hot labor market and zero rates. Market repricing of Fed path (Priority: 5/5): Discussion focuses on how Fed funds futures moved after the meeting, with markets increasing the odds of a 50 bps March hike and pulling rate hikes forward, while the terminal rate remains the key variable. Global spillovers and emerging markets (Priority: 4/5): The conversation connects U.S. tightening to dollar funding stress abroad, with China and other emerging markets facing capital outflow risks, currency pressure, and pressure to raise rates despite weak domestic conditions. Balance sheet normalization and QT plumbing (Priority: 4/5): The hosts debate QT mechanics, stressing that the Fed prefers passive roll-offs over active sales and wants to shift toward a more Treasury-heavy portfolio to reduce Treasury-market disruption. Mortgage-backed securities, housing, and Fed operations (Priority: 3/5): They discuss whether continued MBS holdings support housing prices, and conclude the bigger concern is market plumbing and rates stability rather than directly fueling housing bubbles. Fed governance and trading ethics (Priority: 3/5): A brief segment addresses a Fed official’s trading controversy and Powell’s refusal to take a role in the investigation, highlighting trust and transparency issues at the central bank.

Key Arguments: The Fed meeting was hawkish because Powell explicitly left multiple outcomes open, including 50 bps hikes and every-meeting hikes, which markets interpreted as a tighter path. Inflation appears to be worsening rather than improving, so the Fed is prioritizing price stability over recession concerns. Forward guidance is itself monetary tightening; once markets price higher rates, financial conditions tighten immediately even before the Fed actually hikes. The terminal rate matters more than the exact timing of hikes because the market can absorb earlier hikes more easily than a higher peak policy rate. QT should be implemented carefully because banks, foreign buyers, and market liquidity all absorb Treasury supply differently; a Treasury-heavy runoff is more stable than selling outright. U.S. tightening can destabilize emerging markets by reversing dollar carry trades and forcing foreign central banks to tighten even when their economies are weak. China is unusually well positioned to handle tighter U.S. policy because it has large dollar reserves and capital controls, making Xi’s warning notable and somewhat surprising. Reserves are described as digital cash held at the Fed; reducing reserves can force asset rebalancing and weigh on risk assets. Bank commentary from JPMorgan and Bank of America suggests loan demand and checking balances remain strong, implying the economy is still relatively healthy. The market may be only halfway through the equity drawdown if the Fed stays hawkish and the Powell put is lower than investors expected.

Data Points: FOMC meeting date: January 27 - Recording morning after the Fed meeting March hike odds: ~16.25% chance of a 50 bps hike - Fed funds futures pricing after the meeting March hike odds previous day: 5.7% chance of a 50 bps hike - Fed funds futures pricing on January 25 before the meeting End-2022 hikes priced: 5 hikes implied by 125 to 150 bps - December 2022 Fed funds futures analysis Odds of five hikes: 32% - Pricing after the FOMC meeting Odds of five hikes previous day: just over 20% - Pricing before the FOMC meeting PBOC reserves: $3.5 trillion - China’s sovereign dollar war chest China domestic banking sector dollar holdings: about $1 trillion - Additional dollar liquidity cited by Joseph Bank holdings of treasuries and agency MBS: increased by about $1.5 trillion over the past year - Banks absorbing supply during QE/QT transition Market drawdown expectation: 20% to 30% correction; possibly halfway there - Joseph’s view on risk assets after the meeting Repo crisis reference: September repo crisis - Used as an example of how QT could stress funding markets Inflation estimate change: core PCE estimate raised by a few tenths - Powell’s comments on inflation since December

Pivotal Quotes: "everything is on the table" — Joseph Wang: Describing Powell’s willingness to consider 50 bps hikes and other aggressive options "I'd be inclined to raise my own estimate of 2022 core PCE inflation" — Jack quoting Powell: Used to illustrate Powell’s view that inflation has worsened since the December meeting "I think Paul was very hawkish" — Joseph Wang: Joseph’s bottom-line assessment of the FOMC and its market impact

Implications: Listeners should expect a more aggressive Fed, tighter financial conditions, and higher volatility in rates and equities. The key watchpoints are March hike size, the eventual terminal rate, and how QT is structured to avoid market stress while still draining liquidity.