Joseph Wang & George Goncalves on Rates, Tariffs, Fed’s Balance Sheet, and Yen Carry Trade

Episode Summary

Executive Summary: The discussion centered on the Fed’s 2025 path amid a post-election policy shift. George Goncalves and Joseph Wang agreed the Fed is still restrictive and likely needs more cuts, though both stressed incoming fiscal, tariff, and trade-policy uncertainty could keep it reactive and volatile. They debated December 2024 easing, inflation effects of tariffs, the yield curve, QT, bank reserves, Japan carry-trade risks, and how Trump-era policies may help labor but pressure margins, bonds, and markets in the short run.

Main Topics: Fed policy outlook for 2025 (Priority: 5/5): Both guests argued the Fed faces unusual uncertainty from the new administration’s fiscal and trade agenda. Wang emphasized the Fed will be reactive and cautious, while Goncalves said easing should continue because policy is still restrictive. December 2024 rate decision (Priority: 5/5): They debated whether the Fed will cut again in December. Goncalves leaned toward another 25 bp cut to stay aligned with the dot plot, while Wang argued recent data may remove the need for that cut. Tariffs, trade reordering, and inflation (Priority: 5/5): Wang argued tariffs are not necessarily inflationary in a lasting sense because of FX and margin absorption, but they can depress investment and trigger dovish policy. Goncalves said implementation details will determine market impact. Rates, credit channels, and small business stress (Priority: 4/5): The guests stressed short-term rates matter more for SMEs and households than for large corporates. Goncalves argued high real rates are disproportionately hurting small businesses and lower-income borrowers. Yield curve, recession risk, and neutral rates (Priority: 4/5): Goncalves argued the Fed is staying above neutral too long and that the curve should steepen as cuts resume. Both said the inverted-yield-curve recession signal has been diluted by fiscal support and liquidity. Fed balance sheet and plumbing/QT (Priority: 3/5): They discussed QT approaching a lower-reserve limit and how the Fed might later shift from mortgages into Treasury holdings, possibly toward a bill-heavy portfolio, to ease plumbing stress. Japan, yen carry trade, and global dollar funding (Priority: 3/5): Goncalves warned that wide US-Japan rate differentials can stress global funding markets and revive carry-trade vulnerabilities, affecting demand for Treasuries and risk assets worldwide.

Key Arguments: The Fed is likely to remain data-dependent and reactive because incoming fiscal policy, tariffs, and migration policy are still unclear. Current policy is still restrictive; rates should continue to come down even if the Fed slows the pace. The market may be too hawkish on 2025 cuts, especially if growth weakens or tariffs dampen investment. Tariffs may not be persistently inflationary; they can be absorbed by FX moves or corporate margins and are often a one-time price-level shift. A big tariff push would likely reduce business confidence and investment, making the Fed more dovish rather than more hawkish. High short-term rates hit small businesses and leveraged households much harder than large investment-grade issuers. The yield curve inversion has not cleanly predicted recession this cycle because fiscal deficits and liquidity have masked weakness. The Fed likely needs to end QT as reserves approach a lower comfortable level, then eventually may rotate toward Treasury bills. A wide US-Japan rate differential can revive global carry-trade stress and produce risk-off episodes outside the US. Trump-era reordering of trade and government spending could be positive for labor and medium-term industrial policy, but negative for margins, stocks, and short-run growth.

Data Points: Fed cuts already delivered: 3 cuts over 2 meetings - Set up the discussion on whether another December cut is likely. Cuts priced for 2025: 3 cuts priced - Market expectation referenced early in the conversation. October nonfarm payrolls: 12,000 jobs added - Used as evidence of weak labor-market data with hurricane-related caveats. Unemployment rate: 4.1% - Wang cited recent data as better than the Fed had projected. Fed September dot plot unemployment forecast: 4.4% - Part of the Fed’s September economic projections. Fed September dot plot GDP forecast: 2% - Used by Wang to argue the economy has performed better than expected. Fed September dot plot core PCE forecast: 2.7% - Compared with recent inflation nowcasts around 2.8%-2.9%. Core PCE nowcast: 2.8%-2.9% - Wang said current inflation tracking is slightly above the Fed’s September projection. SME borrowing rate: close to 10% - Goncalves cited small businesses’ actual borrowing costs. IG corporate borrowing rate: 5.5%-6% - Used to contrast large-corporate financing with SME borrowing costs. Fed funds rate: 4.75% (referenced current restrictive level) - Discussed as still above neutral and restrictive. Fed forecast path to neutral: ~17 months - Goncalves cited the SEP as implying a slow glide path to neutral. Neutral rate estimate: around 3% - Goncalves said the market and Fed may still be above neutral for too long. Current 10-year Treasury yield: 4.3% - Used in the discussion of fair value and expected range. 10-year Treasury range: 4.25%-4.75% - Goncalves’ near-term trading range for the 10-year. 2s/10s curve spread: 4 basis points - Referenced as essentially near-flat after re-inversion ended. Fed reserves: 3.2 trillion - Referenced in the balance-sheet/QT discussion as still above the presumed lower bound. Lowest comfortable reserves estimate: ~3.0 trillion - Discussed as the approximate floor before QT should end. Balance sheet runoff pace: $25B/month Treasuries and $35B/month MBS max - Described as the current QT cap on runoff. Fiscal deficit: 6%-7% of GDP - Used to argue fiscal policy is a major support for markets and growth. Scott Bessent plan: 3-3-3 - Referenced as deficit 3%, growth 3%, and oil output +3 million barrels/day. Japan-US rate gap: very wide / near historical extremes - Used to explain carry-trade risk and reduced Japanese demand for hedged Treasuries.

Pivotal Quotes: "I think it's a whole bunch of prayer, actually." — Joseph Wang: His opening view on the Fed’s 2025 game plan amid political uncertainty. "The Fed is going to need to be a bridge loan to the next administration's policy deployment." — George Goncalves: His argument that policy easing should continue while fiscal/trade policies are rolled out. "Tariffs have that impact on inflation, but they also have a negative impact on economic activity." — Joseph Wang: His core case for why tariffs could ultimately lead to more Fed easing.

Implications: Listeners should expect a volatile 2025: slower Fed easing, possible tariff shocks, more curve steepening, and continued pressure on small businesses and leveraged borrowers. Short-run market optimism may clash with medium-term policy disruption and global funding risks.