There are exceptions: Parts of commercial real estate are in a depression, and the housing resale market has frozen.
By Wolf Richter for WOLF STREET.
At the Fed’s post-meeting press conference on Wednesday, Powell will likely re-point out for the nth time that policy rates are mildly or moderately “restrictive,” with the midpoint of the Fed’s policy rates (4.33%) still being substantially higher than inflation rates. Overall CPI inflation accelerated to 2.7%, and core CPI to 2.9% in June, driven by reaccelerating inflation in services, especially non-housing services, and services matter because they’re two-thirds of consumer spending.
The Fed’s policy rates being substantially higher than any of the inflation rates in theory means that these policy rates turn financial conditions “restrictive,” which would then filter via the financial markets, especially via the credit markets, into the economy and restrict demand in the economy, which would allow inflation to cool.
But financial markets have blown this theory beautifully out of the water, they’re practically ridiculing it: Stocks have risen from record to record and are immensely expensive by just about every measure. The meme-stock mania has massively flared up again, where people gang up in the social media with leveraged bets on the most shorted stocks – GoPro, Kohl’s, Opendoor, Krispy Kreme, etc. – causing these stocks to briefly spike by silly percentages. There are signs everywhere that people are taking huge risks with a this-is-so-much-fun attitude, including with cryptos where another mania is in full swing. And margin debt blew out by a record amount, to a record, and is Exhibit A of loosey-goosey financial conditions.
Amid manias left and right, Goldman Sachs reported a 36% year-over-year spike in equities trading volume in Q2, Charles Schwab reported a 38% year-over-year spike, Morgan Stanley a jump of 23%.
And in the credit markets, spreads between high-risk junk bonds and Treasury securities are historically narrow – and that’s Exhibit B of loosey-goosey financial conditions.
Sure, there are some exceptions. Powell cited real estate as an example where financial conditions are restrictive. He cited both commercial real estate, segments of which are in a depression, such as the office sector with record default rates, and residential real estate, where the resale market has frozen largely as a result of home prices having spiked by 50% and more in a two-year period through mid-2022, from already very lofty levels, and those prices don’t make any economic sense. But that hasn’t impacted the overall economy enough to make a dent.
Exhibit A of loosey-goosey financial conditions: Margin debt blew out, spiking by 8.3% in May from April, and by 9.4% in June from May, to a record $1.01 trillion. In dollar-terms, June was the biggest month-to-month spike ever (+$87 billion). Combine margin debt with meme stocks, and it’s magic.
In percentage terms, there were bigger spikes, such as in November and December 1999, just before the Dotcom Bubble imploded – less than three years later, the Nasdaq Composite was down by 78% – and in May 2007 just before the simmering Financial Crisis broke out into the open for all to see.
Exhibit B of loosey-goosey financial conditions: Junk bonds are completely in la-la-land. The spread between BB-rated junk bonds and Treasury securities has narrowed to 1.64 percentage points, according to the Option-Adjusted Spread of the ICE BofA US Corporate BB Index. These BB-rated junk bonds yield only 5.64% on average (the WOLF STREET cheat sheet of corporate bond credit ratings by ratings agency).
A narrow spread between BB-rated junk bonds and Treasury securities means that investors are bidding up prices of these bonds despite their substantial risk of default, and thereby investors are not getting paid to take those risks, and investors just don’t care. They’re eager to take big risks to get a little more yield.
There were a few other times with an even narrower spread after the Dotcom Bubble:
On Mar 9, 2005, spreads narrowed to 1.65 percentage points. And in June 2007, just before nearly everything blew up, they narrowed to 1.71 percentage points.
And then from November 2024 off-and-on through February 2025, the spread was as narrow or slightly narrower than now, despite the supposedly restrictive financial conditions. During the lead-up to, and for a few days after, the Liberation-Day parade of horribles, the BB-spread widened sharply and peaked on April 7 at 3.06 percentage points. But that has now also gone away, and by July 25, the spread was back to 1.64 percentage points.
All of this clearly shows that the Fed’s policy interest rates are not restrictive – however Powell wants to phrase this. Financial conditions in the financial markets are amid the loosest ever. There is no tight liquidity anywhere. Markets are still awash in liquidity. Nothing is restrictive.
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Market expects inflation is headed down over the medium to longer term?
so the $26 lb ribeye is going to moderate
excellent
$50 steaks it is then
and $6 lb hamburger
week ago instead of going to restaurant for burgers
we bought chuck steak and had meat market grind it
2 lbs in freezer
large mushroom swiss burgers
$20
Inflation is continuing to accelerate; however, restrictive interest rates are those higher than the rate of inflation. The only way for the current inflation increase to occur is if inflation is not measured correctly and the control of interest rate being above inflation has a too low rate.
Any engineering control theory course teaches the need for negative feedback to stabilize a system; therefore, this economy needs higher interest rates. What will then occur is the amount of interest over an improperly measured inflation rate will demonstrate a bias requiring a correction factor.
don’t forget the big beautiful debt bill
as MAGA supporter I was NOT IN FAVOR OF UNIPARTY/RINO bill
IMHO this debt is being issued fraudulently
ie never intended on being repaid
Yes, the federal budget deficit is 6%+ of GDP. How much inflation does that cause by itself? There is no way interest rates are restrictive.
The average monthly Federal Funds Rate from July 1 1954 to June 1 2025 was 4.61% (source FRED). Lots of ups and downs. But based on this history, the current rate of 4.33% is a little loose, not restrictive. Curiously, the median over the same time period was 4.33% which is exactly the same as the current rate.
The FOMC ought to step up ST rates by 100 bp easily over next 12 months. The market signals have been there all along. Corollary: the general indices of price inflation are intentionally suppressed by the govt.
I agree with all of this and have been proven wrong as the S and P shot to 6300 from 5,000 in a matter of months. What’s the counter narrative here?
Counter narrative is valuation alone is not enough to blow up the stock market. Need a recession, etc to blow it up.
Thank you for stating the obvious in clear terms Wolf.
And No Thanks to the Academics at the Fed that bury their heads in their Models and Theories without regard to reality.
The idea that they should ignore financial markets in their policy settings is frankly ridiculous and the Financial Journalists should call them out on it.
Every meeting.
This is one of the most important articles available to understand financials conditions…would love if this could be published monthly similar to the housing updates. Thanks, Wolf!
chase won’t allow CD’S in IRA’s
Merrill does, but bills pay more and are more liquid.
TBills that is, AI auto correct working well.
There is some truth to this but the Fed absolutely CANNOT “go with their gut” when guiding the USA’s monetary policy. Computers and The Internet changed the game and it will take time for science to understand and predict well under the new way of things, the producing better predictive models.
They can use existing models, be somewhat wrong, examine everything, and improve for the future. It’s not perfect but it works.
But if they make policy based on those new theories without the backing of history then policy will fly all over the place (because there are many such theories) and they’ll get lambasted for any mistakes because they’ll have no justification but “it felt right”.
It’s easy in hindsight to point out some theory that clearly predicted the past forgetting that, in the past, it was only one of a dozen contrasting theories of which none was obviously correct or widely accepted.
I didn’t say the Fed should be “going with their gut”.
My point is that they NEED to value and emphasize market conditions in their monetary policy decisions, especially when they are so clearly making a statement about the looseness of financial conditions.
Market pricing is a reflection of millions of decision makers, betting their own and others money and thus a valuable input.
There are no Academics at the Fed. That department was eliminated.
It’s not “frankly ridiculous”, it’s the law, which spells out the Fed’s responsibilities, which do not include being a welfare program for stock investors.
I think all of this demonstrates that while QE is sufficient for loose financial conditions, it’s not necessary. 3 years of QT hasn’t really affected financial conditions, even as the money has been withdrawn, as the psychology of investors hasn’t changed.
People are investing like this because they think they can’t lose. Only a prolonged bear market will shatter that ingrained belief.
People are investing because they believe the fed will step in and intervene.
Look at the markets pre SVB bailout and then after. The market doesn’t believe that a bear market can ever take place.
That seems true for now. A non ‘too big to fail’ was deemed ‘too connected’ to fail and saved out of compassion for the little guy. Oh wait….
Investors in SVB got wiped out. Uninsured depositors got bailed out…. meaning people and companies with over $250,000 on deposit at SVB. Deposits of less than $250,000 were insured anyway. Turns out, deposits of billionaires’ startups and rich Silicon Valley people’s own deposits were bailed out. So not exactly the “little people.” The little people had deposit insurance and would have been fine. The big people exceeded deposit insurance and would have gotten a haircut of maybe 20% on their deposits. Not the end of the world. The banking regulations and FDIC rules should have been allowed to work and do their jobs.
Unfortunately, this is correct.
People have this idea that asset/equity prices can go up forever and ever without end or pause. It’s creating a lot of bubbles – see real estate. I still see idiots/scammers around who say that stocks or real estate or crypto will never go down so you should get in now.
To break this mentality, prices for assets and equity can’t merely go down (and they will, a lot) – they have to stay down for a long time, preferably at least a decade if not two. Long enough that people quit thinking that owning financial assets is a guaranteed route to endless riches. Only then will sanity be restored.
I agree with you, but I want to add to it. It needs to go down, and Congress and the Fed have to ignore the caterwauling from the mainstream media, that represents the rich and powerful, to “do something.”
“do something.”
Exactly.
A big (perhaps, huge) part of the unprecedently aggressive “investor” mindset on valuations is the (far from unfounded) sense that any significant asset price decline (no matter how justified) will be met by a DC “printer’s put” in order to “fix things”.
And the resultant chaos from the resultant inflation?
These people don’t think that far ahead (or use it to justify taking/selling financial meth to “win” inflation’s Red Queen’s Race).
I’m going to take the other side of this. I listen to a lot of Gen Z’ers in my workplace and there’s a common theme that they feel like they can’t get ahead when it comes to home ownership, plagued by student loan debt, persistent inflation, and have difficulty saving. Their thoughts on the stock market is a lotto ticket to them getting ahead. I don’t necessarily agree with all of this, I’m just telling you what they’re saying.
Student loans are a personal decision.
My granddaughter went through college applying for grants and scholarships and came out debt free. It’s really not that hard to do this or even just come out with very minimal debt. also, she had a part time job while in college. .
Agree, it’s less about current policy and more about the expectation for dovish future policy. The equities owning public, top 50%, has seen how dovish the Fed and congress will get in the face of any slight hiccup, and are placing bets accordingly.
coming great reset is getting boost from
big beautiful bill
issued fraudulently with no intent on repaying
QE was so huge that the small amount of QT has only put a dent in the amount of money QE injected.
Maybe they should have kept the QT rate higher for longer.
Perhaps another example of these trends is mainstream banks finding ways to lend into private credit deals, extending credit to firms they would traditionally refuse or charge more in interest to. This reminds me of banks rushing to make foreign loans (many times over centuries), preceding big financial system stresses. It could be a mispricing of risk, driven by competitive pressures (keep dancing as long as the music plays, right?), and the feckless current regulators have no eyes or handle on it. (I was pleasantly amazed in the COVID crisis that Trump’s appointees such as Mnuchin and in that moment anyway, Powell, had some ability.)
There are so many institutions and relationships exposed suddenly to potential volatility due to the political change in climate, with such complex crossovers and mixtures (private credit plus stablecoins, loosened regulatory oversight, political Fed pressures, etc.), with plenty of opacity in all the possible mixups and mashups, I think one thing that could cool these markets is something unforeseen breaking across new fault lines, inducing losses in unexpected places.
I got 4% seller carryback
only put down 70%
The current interest rates should be mildly restrictive, but are having no effect on the handful the tech stocks that dominate the stock indexes. The big techs are fueling the impression that interest rates don’t matter. Nvidea doesn’t care about another 100 basis points. The uphoria about the overall SP500 index price is raising all the boats in the water. How else can you explain 200x pe ratios for companies like Tesla?
Higher interest rates make about as much sense as lower interest rates in this fairy tale land.
However the music will eventually stop, and many boats will crash in the rocks. Interest rates will once again matter.
Fed should be accelerating QT instead of slowing it.
I expect they would prefer that. The risk is that they go too fast, something breaks, and they have to do another bout of QE thus undoing much or all of the work done so far.
If no speed limit is posted but you know you’ll get your car impounded if caught speeding, how fast would you drive?
They’re playing it safe. We’re going in the right direction, according to the Fed mandate which does not include the stock market. I generally agree with them.
Brian, fantastic analogy.
While I would also like to see the Fed increase the rate of QT, I acknowledge that breaking things would put the whole institution at risk thanks to one particular pushy, button mashing politician. A slow fat burn doesn’t overwhelm the system as much as a 1,000 calorie diet paired with daily half marathon runs.
The Fed is caught between a rock and a hard plate. It they lower short term interest rates now, the ones they control, the long term rates will go up like they did last fall, including the 10 year Treasuries, 30 year notes, and further hurt the housing financing market, CMBS refinancing, etc. If they stay pat they will be get pounded by the current administration like there is no tomorrow. They are is a LOSE LOSE situation. I predict they will stay pat and let the markets determine long term interest rates which given the strong economy cited above will go up anyway and lead to a money crunch for those industries which rely on long term debt refinancing.
Getting “pounded” by the president is part of the Fed chair’s job. The president can push for low interest and then blame Powell for not delivering. This is why the law makes it “illegal ” for the president to fire the Fed chairman despite the constitutional provision that executive power is vested in the president. Good cop bad cop.
Even if Trump doesn’t understand that, I suspect his advisors do.
I think what he’s doing is lambasting Powell so that if and when something breaks, he can say “See! I told him he should have lowered rates!” But on the same token, he doesn’t actually want the long-term yields blowing out and further damaging the economy.
The rock and hard place is their foray into the Long End which gave them a one Trillion paper loss
They always finds the rock and the hard place when they try to make water run uphill
Isn’t creating money out of nothing…balance sheet gimmicks a form of magic? Is not the pen mightier than the sword? With the flick of a pen new reserve money is created on the books ..he who controls the books, controls the world …we have too many rackets…money being king. TC.
Perhaps the Fed is more worried about the leverage in the markets than inflation ? It would seem a little more regulation
would have sim plied the Fed’s position
in the long run.
We should start evaluating whether the spread is narrowing less because investors are underplaying risk on credit and more because they perceive Treasury securities as having greater risk relative to corporates. Of course Treasury securities are “risk-free” in an important credit sense, but the last 15 years, especially the last 5 years, has shown an appetite for political wrangling that threatens the stability of the Treasury bond market. Debt ceiling negotiations have regularly threatened technical defaults, and there has been open talk of restructuring by altering maturity terms of existing Treasury securities. There has been talk of applying default or restructuring selectively based on the holder.
I am not suggesting I am certain of this effect. I am just saying we need to start evaluating a model where there is a hypothetical no-credit interest rate and a “political risk” spread on Treasury securities. Under this model, it may be that it’s not the credit spread for corporates narrowing. Instead, it’s a stable credit spread but widening political risk spread for Treasuries.
To put it differently, who would you rather lend to? Microsoft or Congress? There is a point at which political dysfunction will make you more confident in Microsoft.
“To put it differently, who would you rather lend to? Microsoft or Congress?”
1. Here we’re talking about BB-rated junk bonds, not AAA-rated Microsoft bonds (one of just a few US companies with a AAA-rating).
2. Microsoft can go bankrupt, like so many formerly big unbeatable iconic AAA-rated companies have (remember Kodak?).
3. But Congress cannot go bankrupt, though it’s morally already bankrupt.
Howdy Folks. Bubba says its time for Greenspan. Maestro would lower, lower, raise, lower, lower, lower, lower, raise, maybe lower, maybe raise, raise, raise. Believe it or not??????
Wolf,
Do you think there is a fed rate at which your examples become restrictive that isn’ so high it crashes the economy? While I agree the current rates aren’t “acting” restrictive for either Exhibit A or Exhibit B I think it’s more an example of the phycology of the investor than the restrictiveness of the current rates. I get the feeling that the general age/maturity of current investors tends to slant more to the lower end of the spectrum (my opinion, its more a feeling though I’d be curious if there is actually any historical charting of investor experience levels) so they really haven’t lived through a time when “everything” was going bad, so they don’t have the kind of ingrained fear more experienced investors have. Between that and the advent of Robin Hood, et al which makes the process easier – is this just a case of the guy at the slot machine betting his rent on an “investment” that in his short time has “always” paid off? I would think that type of person isn’t even factoring in the margin rate because if everything is a sure bet any margin rate will just take a bit off the top of their winnings. And I’d assume (maybe incorrectly) that similar to 2008 the people on the other side of those margin rates (Robin Hood, Schwab, etc.) are so giddy with the money it’s bringing in that they are being a bit looser with credit than they ought to be.
Wolf, you added a third building.
Brilliant
Margin debt dropped 30% twice on the chart. Markets dropped too but obviously recovered and did fine. Not sure margin debt is a great indicator of anything other than margin debt.
The November and December 1999 reference of margin debt in the article is not shown in the chart. The Nasdaq dropped 78% from its high in March 2000 and took 15 years and lots of QE and 0% to get back to its old high. The S&P 500 dropped 50% and took 13 years and lots of QE and 0% to go past its March 2000 high.
But those are the index values. If you owned individual stocks, and not the incices: Thousands of stocks were either zeroed out and became worthless or were bought for a few cents to a couple of bucks and then vanished.
Many investors who were margined were completely wiped out, with essentially nothing left in their accounts.
But yes, no one invested in a market like this takes any warnings about a market like this seriously. That’s why these kinds of markets can exist – until they can’t.
Investors in 1999 and 2000 didn’t have the guaranteed store of wealth that they do today: crypto.
A permanently high plateau of a permanently high plateau.
/sarc
Buy a 6% BB-rated bond that’s been trading stable for the last year on good economic data or buy a 4.4% treasury that’s going to lose value as soon as the debt limit is raised? The narrow spread is not surprising. It’s a fiscal problem, not a monetary one.
“Depth Charge
Feb 8, 2023 at 3:03 am
“If I were Powell, I’d be getting the willies just about now.”
Yet when I was calling for the FED to continue with their 75 basis point rate hikes until they reach the rate of CPI I’m accused of “just wanting to burn it all down.” Now look, they’re falling behind.
The fact is that the FED blew it by quickly ratcheting back to 25 basis point hikes, especially given what’s transpired since September. All of the signs were there, they just ignored them. There is absolutely no good reason why they didn’t do 50 basis points last meeting. Just an abysmal failure of a job.
I contend that the FED is playing a role of fake tough guy on inflation, with the actual goal of hyperinflating the price of all assets permanently. There’s no way they’re as incompetent as they’re acting. They know that the longer they string out this inflation, the higher prices will be in the end.”
I called all of this years ago. They are intentionally blowing the biggest asset hyperbubble in history, and trying to make it stick.
When they first “paused,” I immediately stated that asset prices would be setting new highs, yet was told that there was no way that could happen because their rates were “restrictive.” Nope. This whole outcome was so obvious that Ray Charles saw it coming.
Your Ray Charles joke ruins what might otherwise be a post with arguments worth considering. The joke implies you have poor judgment and instead just want to be provocative.
“with their 75 basis point rate hikes until they reach the rate of CPI”
They blew threw the rate of CPI with their rate hike in May 2023 to 5.0%-5.25%, while CPI had dropped to 4.9%. And CPI continued to drop, eventually reaching a low of 2.3% in April.
Some finance writers say margin debt doesn’t matter as much as option notional values these days. Is that true? (Or does option notional still end up reflecting in margin debt somehow… e.g. the market makers hedge their options exposure with futures that increase their margin debt?)
Just read that Jim Cramer had a bit of a meltdown about rates on TV again – the last time back in ’08 I think he was onto something in terms of his WS buddies opening their office windows. Maybe without a constant promise of cheaper and cheaper money even at ATH the whole bubble is about to explode. These guys want permanent ZIRP so that everything doubles in price every three or four years. Even +10% a year is no longer enough to keep the plates spinning.
The 20s are roaring, baby.
‘including with cryptos where another mania is in full swing.’
Juiced by the executive branch of govt that is beyond crypto friendly to the point of being a participant.