Alfonso Peccatiello: Inflation is Destroying the Fed’s Credibility
Tom welcomes back Alfonso Peccatiello author of the Macro Compass Substack to the show.
Alfonso believes the Repo markets could be the most important part of the pyramid going forward. The system is continuing to add more layers and levels to the way markets work. Repo markets exist below bonds at the very base of the pyramid. Repo markets allow for leveraging of bonds and treasuries.
Repo markets are very active to the tune of trillions per day. Pension funds, asset managers, or corporate treasurers are on the other side of these trades. So long as financing costs are predictably low, there aren’t many problems. There is a lot of cash chasing a limited amount of collateral. When Repos become unsteady, it shakes the entire pyramid structure. These markets can become very tight rapidly.
The Fed has not changed its inflation targets. They want to be improving inflation expectations because it impacts their credibility. They are very committed to shrinking their balance sheets. The chances of a soft landing in this environment are quite low. It will likely take a fairly big recession to bring inflation back to two percent. Probably a recession that lasts up to two years. However, the system is much more leveraged and fragile than in the past. This makes addressing the problems much more complex.
He shows us the G5 Credit Impulse chart. It reflects private sector bank balances and if they are increasing or shrinking. This is indicative of economic activity across the G5 nations and is a leading indicator of economic activity. It’s currently falling off a cliff, and therefore economic growth and earnings are likely to fall further.
A recession is when people are fired and are losing their jobs. This shows up in business models that start to crumble, and then bleeds over to the rest of the economy and housing. He says, “We are going to have a proper recession.”
Markets want to make money, and they wish to hear that inflation is coming under control. However, this is not the case. We need momentum for inflation figures to decline. Investors should be cautious in the risks they take with their portfolio.
Something very foundational will have to break for the Fed to change to a dovish approach. There will be a point where they have generated enough ‘damage’ to the economy where inflation control is regained.
Talking Points From This Week’s Episode
- The importance of the Repo markets and why they are foundational.
- Fed’s inflation targets and why a pivot may be quite some time away.
- Defining inflation and why the Fed has to get it under control.
Time Stamp References:
0:00 – Introduction
1:05 – Bond Markets & Repos
3:45 – Repo Trading Volume
6:20 – Managing Repo Risk
9:29 – 2019 Repo Problems
12:20 – Bear Traps & Inflation
18:04 – Tightening & Bankers
22:06 – A Soft Landing?
25:03 – Job Markets Report
29:32 – G5 Credit Impulse
34:02 – Recession Nuances
35:48 – CPI Prints & Fed Targets
41:58 – Force a Fed Pivot?
44:40 – Portfolio Positioning
48:33 – Wrap Up
Alfonso Peccatiello is a former head of a twenty-billion-dollar Investment Portfolio and is a passionate global macro investor. He writes The Macro Compass, a financial newsletter providing actionable investment ideas and unique macroeconomic insights to enhance the risk/return of your portfolio.