Basis Points: Talking Fed with Kevin Flanagan, Ep #52

Kevin Flanagan started his career as a Fed watcher i.e. money market economist working on the trading floor. As a fixed-income strategist, he looks at things from a broad perspective because numerous things impact the bond market—economics, geopolitics, elections, etc. All play a role in how the bond market and interest rates are developed.

He found it fascinating that you could look at the past and present to gain insight into the future. Kevin joins me in this episode of UPThinking Finance™ to shed some light on this confusing topic.
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LISTEN IF YOU ARE INTERESTED IN…

[1:59] The “new” old-rate regime
[8:36] When the Fed’s role shifted
[14:51] Politics playing a role in policy
[16:55] Current impacts on inflation
[21:55] The impact of foreign money
[24:50] What will happen with US debt?
[28:40] The performance of the municipal market
[30:45] Where Kevin sees the bond market headed
[32:47] The connection between the 10-year and gold
[35:02] How Kevin got into the fixed-income arena
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The “new” old-rate regime

Before the financial crisis, double-digit interest rates did exist. After some time, we nestled into a 3–5% range. From 2010–2020 there were even negative rates. That period was abnormal. But because of recency bias, we’ve forgotten that what we’re seeing now is closer to a “normal” level. We’re moving back to normalcy. We likely can’t return to the pre-covid levels of interest rates. There’s also a generation of advisors and investors who have to be reeducated about interest rates.

The volatility in the treasury market at the levels we’ve witnessed has to do with the uncertainty with interest rates. It’s the uncertainty that is new to the bond market. And the more open the Fed is with communication, the more openings there are for misinterpretation. The bottom line is that things can change very quickly. We can’t rely on what’s worked and must pivot and adapt.

When the Fed’s role shifted

It’s no secret that the main driver for the prices of the equity markets is the movement of the Fed. Bond guys like to say “Rates make the world go round.” Everything starts with interest rates. And who sets interest rates? The Federal Reserve.

As things have evolved in the bond market, there was always a clamoring for the Fed to be more open. The process of open communication has evolved deliberately. The Fed now gives a policy statement, press conference, and summary of economic projections.

Kevin believes there are three people you need to watch when the Fed makes its announcements—The Chairman, the Vice Chairmen, and the President. They speak on behalf of the Fed and policy. They may not always be the ones getting the media attention.

For example, a Fed Governor is a voting member of the Federal Open Market Committee. One of the governors, Christopher Waller, was on the hawkish side when the Fed started raising rates.

When he changed his narrative, it added to the momentum of the market expecting a reversal toward rate cuts. The market rallied in the 4th quarter and got ahead of itself. The validation never came. The economy and labor markets are proving more resilient than expected and inflation is stuck in the mud. Everything is interrelated and important.

Kevin feels that Powell is itching to cut rates. But they need a reason to do so. If that reason comes, the Fed will cut rates, regardless of it being an election year.

Understanding outside impacts on inflation

Why is the economy resilient? Why is there still inflation? Part of it is because there’s still a lot of money floating around. The amount of government stimulus that came post-covid was enormous. The US is running in a $2 trillion deficit because of government spending. That can’t be dismissed as a factor.

How do elections impact inflation and the movement of the Fed, if at all? Where does Kevin see the bond market headed? Listen to hear Kevin’s expert opinion!

Kevin Flanagan is not affiliated with or endorsed by LPL Financial or Capital Investment Advisers.

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