Joseph Wang: Bonds Will Be Crushed By Stocks As Fiscal Deficits Reignite Inflation

Episode Summary

Executive Summary: Joseph Wang argued that 2024 will likely see inflation reaccelerate after a temporary disinflation phase, driven by persistent fiscal deficits, strong household balance sheets, and still-solid demand. He expects stocks to outperform bonds, the Fed to cut only modestly, QT to continue well into 2025, and housing to benefit from lower rates. He also emphasized rising politicization and the growing dominance of fiscal policy over monetary policy.

Main Topics: Inflation outlook and the end of disinflation (Priority: 5/5): Wang says recent disinflation was supply-driven and temporary, not a return to the pre-2020 regime. He expects inflation to rise again later in 2024 as supply improvements fade while demand remains strong. Demand strength from households and fiscal spending (Priority: 5/5): He argues that wages, net worth, and financing conditions all remain supportive of spending, while large deficit spending acts like helicopter money and keeps aggregate demand elevated. Stocks versus bonds in 2024 (Priority: 5/5): Wang’s base case is that equities will outperform bonds decisively because fiscal expansion and growth support risk assets, while bond yields face pressure from heavy Treasury issuance and rising term premium. Fed cuts, market pricing, and the yield curve (Priority: 4/5): He believes the market is pricing in too many cuts, the Fed will likely cut only a few times, and the long end of the curve may sell off even as the Fed eases because supply/demand and term premium are worsening. Quantitative tightening and reserve plumbing (Priority: 4/5): A major focus was how QT will likely continue longer than the market expects, with the Fed gradually tapering it once reserves approach the minimum comfortable level; Wang discussed reserves, RRP, and how Fed balance-sheet mechanics work. Housing, mortgage rates, and mortgage-backed securities (Priority: 4/5): Lower mortgage rates should boost housing activity, especially new construction, but Fed MBS runoff is still constrained by low prepayment activity after the mortgage-rate shock of 2022-23. Politicization and the rising role of fiscal policy (Priority: 3/5): Wang suggested the Fed may be less aggressive in pushing back against market rate-cut pricing in an election year and that fiscal policy is increasingly the main driver of markets and growth.

Key Arguments: Recent lower inflation readings are mainly the result of improved supply chains and higher labor force participation, not the elimination of inflationary pressure. Supply-side help is largely exhausted, while demand remains elevated due to strong wage growth, record household net worth, and cheaper financing. Large U.S. deficits function as helicopter money because Treasury issuance creates liquid financial assets while government spending adds net purchasing power to the private sector. Stocks should outperform bonds because fiscal spending supports earnings and growth, while bond yields face upward pressure from heavy issuance and higher term premium. The Fed is likely to cut rates, but not as aggressively as markets expect; the long end can still rise even if the short end falls. QT will probably continue through 2025, with tapering beginning around late 2024 as reserves move closer to the Fed’s notion of ample reserves. Housing should improve with lower mortgage rates, especially new construction, because demand is driven by demographics and life-cycle needs, not just rates. The Fed and broader institutions may be more politically influenced than in the past, which could limit public resistance to market expectations of easier policy.

Data Points: Inflation (year-over-year): 3% to 4% - Current inflation remains above the Fed’s target even though recent monthly annualized readings are near target. Inflation peak: 9% - Wang referenced inflation falling from its peak to around 3%. Household wage growth: about 5% - Used as evidence that household income remains strong. Household net worth: all-time highs / around all-time highs - Based on Federal Reserve data through September, with stocks and home prices rising since then. Nationwide house price appreciation: 25% to 30% - Used to illustrate broad wealth gains from the housing market. Homeownership rate: over 60% - Supports the argument that housing gains are benefiting a broad share of households. Household debt servicing ratio: multi-decade low - Because many households are locked into sub-4% mortgage rates. Fed deficit estimate: $1.8 trillion - Projected fiscal deficit cited as evidence of ongoing helicopter-money-style demand. Deficit spending share of GDP: 7.5% - Used to argue that recession talk is hard to reconcile with fiscal support. GDP nowcast: 2.5% - Current growth estimate cited as evidence against recession. Fed funds market pricing: 6 rate cuts - Market expectation Wang says is too aggressive. Fed dot plot expectation: 3 cuts - December dot plot suggested a less aggressive easing path. Fed balance sheet QT pace: $95 billion per month - Maximum monthly quantitative tightening pace under current framework. Reserve level estimate from 2019 comparison: a bit below $3 trillion - Approximate lowest comfortable level of reserves inferred by projecting 2019 reserve/GDP ratios forward. Current reserves: slightly above $4 trillion - Used to argue the system still has a large cushion before QT becomes constrained. RRP facility: approach zero by the first half of this year - Wang expects reverse repo balances to continue draining in early 2024. 10-year Treasury yield: just over 4% - Cited after having dipped below 4% and previously been around 5% in October. 10-year Treasury yield in October: 5% - Shown as a recent peak before the rally in bonds. Mortgage rates: 8% peak, around 6% as a potential lower level - Wang said 8% did not break housing and 6% would likely stimulate it further. Mortgage refinancing stress test: 2020 prepayment rates around 50%-60% in some states - Illustrated how rate shocks can trigger high prepayment activity.

Pivotal Quotes: "I think the big surprise this year, though, is that we find out that disinflation was actually transitory." — Joseph Wang: His core 2024 macro call on inflation dynamics. "I think stocks will absolutely crush bonds this year." — Joseph Wang: His forecast for relative asset-class performance in 2024 and beyond. "We are doing helicopter money full force." — Joseph Wang: His description of the fiscal deficit’s impact on liquidity and demand.

Implications: Listeners should expect a macro regime where fiscal spending matters more than Fed policy, inflation may reaccelerate, bonds may face renewed pressure, and equities/housing could remain supported. QT and politicization are key risks to watch.