E15 - Decoding the Fed [PODCAST]

Lundy Wright

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Fed watching has become a national sport of sorts. Given the unprecedented actions taken by the Fed to navigate the country through Covid, this sport has perhaps grown faster than any other in our nation’s recent history. And, of course, what sport would be complete without a constant stream of new information to analyze? For that, we have economic numbers that drive the narrative behind the great guessing game of what the Fed will do, and when. In this episode, G3 chats with bond pro, Lundy Wright, Senior Vice President and Portfolio Manager at Weiss, to put the Fed’s actions and recent economic data into context.

 

 

Before Lundy was the resident bond savant at Weiss, he worked at Morgan Stanley for 17 years. At Morgan Stanley, Lundy was the fixed income representative at the equity risk meetings with Jordi Visser. They built a strong bond, which after a detour at Nomura, led Lundy to the open arms of Weiss. Getting down to brass tacks, Lundy reminds us that equity guys talk about the Federal Reserve occasionally at cocktail parties, whereas bond guys talk about inflation and the Fed constantly. Further, in his role as the head of a desk and a risk-taker, this is an important prequalification for Lundy’s approach to analyzing the Fed’s movements.

In the fall of 2018, the Fed changed its policy to AIT—Average Inflation Targeting. Historically, the Fed has had a dual mandate of maximum employment and price stability. It seeks the most efficient, high level of growth, while buffering the swings that could destabilize the economy. In effect, this led to a systematic undershooting of inflation. Conversely, AIT allows the Fed to keep the “punch bowl” at the party for longer, which Lundy believes contributes to higher levels of inflation, albeit at the risk of higher price volatility.

Lundy opines that with an increasingly dysfunctional Congress and an overreliance on the Fed, the Fed is losing its independence, and perhaps its credibility. The Fed can affect policy change overnight, but getting a bill pushed through Congress can take more than a year, if at all.

Lundy says the Fed was (partially) created to embody the “Fed Put,” the idea that the Fed will rescue investors from too much market turbulence. Today, even with the Fed’s aggressive support of risk assets in the past several years, Lundy insists that the Fed Put remains intact. The problem, as G3 points out, is that the economy 30 years ago was less intertwined with the fortunes of the stock market, and it’s not necessarily a good thing for investors to be aware of and reliant upon the Fed Put.

Something Lundy takes issue with is the Fed’s insistence that it has the tools to combat inflation because the last time the Fed was seeking to curb inflation, Paul Volcker drove the economy into a wall. Therefore, Lundy says that the appropriate follow-up question is, what are the tools?
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