Is Treasury Policy Buying the Fed More Time?

[00:00:00] Speaker 1: Well, stocks are sitting near record levels, but with monetary policy in focus, what should investors expect over the next 12 months and where should they position? Let's dig into all of that with Darius Dale, founder and CEO of macro research firm 42 Macro. Darius. Thanks very much for joining us. [00:00:31] Speaker 2: Thank you for having me, Roger. [00:00:33] Speaker 1: Appreciate you. Okay. You're bullish over the next 12 months, but cautious right now. Why the bull? Why the caution? I was going to say cosh, but I don't think that's a word. [00:00:42] Speaker 2: No, look, it's a great way to characterize it. We're still in a bull market. This paradigm C bull market that we got started for you guys back in April of last year. A lot of the macro tailwinds, particularly on the growth side and on the fiscal policy side, which ultimately leads to better outcomes on the liquidity side, are still intact. However, from the perspective of the next few months, we've been coaching our global investor community to anticipate tightening, monetary tightening by the Fed, not in response to necessarily inflation pressures or anything wrong in the economy, but more in response to the backup in our star and the backup in the neutral rate in order to appease the bond market, the bond vigilantes. [00:01:17] Speaker 1: And we have seen bonds sneaking up over a little while. What could maybe change or what could throw a spanner in the works? [00:01:24] Speaker 2: Well, I'll tell you right now. We just published a couple of research reports to our global investor community. This one this morning titled, "Is Treasury Secretary Scott Besson, a former client of mine, is he bailing out the market again?" And the answer to the question was yes. And here's why. The Treasury is shifting its ratio of dovish net financing policy from a negative 21 percent in Q2 to positive 61 percent in Q3 and positive 58 percent in Q4, which compares to a trailing three-year median of about 41 percent. And the reason that's positive is because it's sort of--it's artificially restricting the incremental supply of duration risk across global financial markets. And in a way, that can sort of back the bond vigilantes off for a second to give Fed chair Kevin Warsh and his colleagues on the FOMC some breathing room to hopefully, you know, gain some more credibility on inflation with a few, you know, soft inflation reports. If we get a few soft inflation reports between now and the next Fed meeting, you can essentially throw away our play action pass to set up the run theme, because ultimately, Scott Besson, will have created the bridge for them to get to the year end. [00:02:28] Speaker 1: And do you think that's enough what he's doing? Will that appease? [00:02:32] Speaker 2: I think that's exactly what he's trying to do. You know, the jury's out on whether that'll be rewarded by financial markets. But in our view, this is arguably the most significant policy signal that we've seen throughout the year to date from any government around the world. This is a Treasury secretary who's responding to what has been our core research thesis for years now, since the summer of 2023, which is that there is a geopolitically driven supply demand imbalance in the Treasury bond market. Clearly, Japan is a contributor to that, particularly in the context of Prime Minister Sineetake Aichi's reflation agenda. But you also have remilitarization in Europe. That's calling--that's a capital call for their capital to come home as well. You have strategic decoupling with China. That's a capital call away from our Treasury bond market as well. And then you also have many countries in the Global South who are increasingly disfavoring the U.S. dollar as in the global reserve asset. [00:03:22] Speaker 1: And one of your themes called "run it hot," but then let's throw in a little sticky inflation. [00:03:28] Speaker 2: Yeah, absolutely. I mean, sticky inflation is a natural byproduct of trying to run the economy hot, which we noticed, you know, I would argue well before Global Wall Street did back in the spring of 2025 when, you know, the world was really freaking out about tariffs and the impact that tariffs would have on the global economy and on inflation. But we were focused on the very clear policy shift from trying to tighten the budget deficit, which is paradigm B in our framework, to pivoting to trying to run the economy hot with fiscal policy easing, regulatory easing, which is paradigm C in our framework. So our clients have been positioned for paradigm C since mid-April of last year. [00:04:01] Speaker 1: All right. And taking a look at the markets, you like the global stock market, equal weight S&P 500. MAG-7, not so much. Have they run their course, at least for now? [00:04:12] Speaker 2: Yeah, we don't have a particular bone to pick with MAG-7 in absolute terms. We just believe that the investors, considering that MAG-7 was really a core position for a lot of the global investors and institutional capital allocators, that they would use that as a source of funds to capitalize other businesses, particularly businesses that are beneficiaries of all the AI CapEx and will eventually be beneficiaries of AI itself in terms of expanding gross and operating margins. [00:04:37] Speaker 1: And with the CapEx, you are warning of a bubble there. I mean, many people are talking about it becoming almost like infrastructure, but you think there could be a bubble, even like what we saw with the dot-com and even the railroads? [00:04:50] Speaker 2: Well, look, the standard lexicon on global Wall Street across any asset or any statistic is that if something doubles in under two years, that it's typically considered to be a bubble. Well, we've doubled AI CapEx, not we, but the hyperscalers in the U.S. have doubled AI CapEx year after year after year for several years. And so ultimately, I do believe that we are in a CapEx bubble. Now, the best part about this CapEx bubble from the perspective of investors who are long, the stock market, long risk assets, is that the companies themselves are now starting to appreciate the signals from the markets, particularly the hyperscalers, that they are spending too fast. And so what we saw during Q2 earnings season was some reassurance by companies like Microsoft, some reassurance by companies like Amazon that they're going to, you know, really focus on the monetization of all that CapEx to give investors confidence that, you know, they're just not throwing trillions of dollars down into a black hole. [00:05:40] Speaker 1: And could you see them pulling back on CapEx or does that have to, that's going to go no matter what? [00:05:46] Speaker 2: Certainly it'll slow in rate of change terms. If it actually outright declines, that's probably the end of this bull market and we're not forecasting that outcome, at least not over the medium term. All right. [00:05:55] Speaker 1: And what other factors could we see over the next 12 months that might change your bullish approach? [00:06:00] Speaker 2: Well, the number one thing we're focused on from a medium to longer term perspective is the outcome of the task forces from the Federal Reserve. Recall that Chair Warsh has instituted five task forces to essentially try to reform the Fed's reaction function, reform the Fed's whole entire policymaking apparatus with the exception of changing the congressionally mandated price stability mandate and the maximum employment mandate. And so it's our expectation that the net result of those five task forces will be dovish and have dovish policy implications from a forward-looking perspective whenever we get those results, maybe in Q4 or Q1 of next year. And if that is true, then ultimately what Scott Besson, what Treasury Secretary Scott Besson is doing right now to buy the Fed some time to get to that outcome, if that ultimately is successful, then you can go from a situation where the Treasury's holding the hand of the market to where the Fed will be holding the hand of the market and you could easily see a bust, a bubble in the stock market, which is something we were calling for since last summer. [00:06:56] Speaker 1: Okay, we have to wrap it up there, Darius, but thanks very much for joining us. [00:07:00] Speaker ?: Thank you. [00:07:01] Speaker 1: Darius Dale, founder and CEO of macro research firm 42 Macro.