Are you expecting that to continue?

Well, certainly, you know, I think the story here is best understood at a disaggregated level, right? There is the AI boom beneficiaries and there's everybody else.

So if you look at equal weight S&P, as you guys know, equal weight S&P has already taken a substantial hit from rising yields.

and there are a number of stocks in a lot of sectors that are down quite a lot from their highs what's kept the aggregate index very close to record highs is of course the strength of the ai related names although that's come under pressure from this specific open ai news the specific apple questions and so on in the last 24 hours the broader theme is still that it's a common shock that's pushing up expectations of ai related earnings on the one hand and pushing up yields on the other.

So those stocks that are benefiting from the same things that are pushing yields higher are not surprisingly proving pretty resilient.

Krishna Guha, I hate to throw that in your lap, but it does lead me to a question about what's been driving yields in aggregate, tariffs, the war, deficits, but also the notion of Fed independence, especially when you apparently are creating superjudicial instruments of regulation.

Yeah, look, I'm responding as you are on the fly to a statement that I haven't seen fully.

But this is massively counterproductive if, as president, what you want to do here is to create circumstances in which the Fed raises rates less rather than more and yields moderate from current levels.

Right.

And then at what rate does the whole thing start to weaken significantly because you're even stressing the AI side and the stock wealth gains that are associated with that? So I think we're already clearly in territory, uh, you know, with a five handle, which is putting strain on the non-AI, uh, parts of the economy.

Um, you know, you, you will see some crowding out, uh, of things that would've been done in other sectors because the borrowing cost is now too high.

Ground zero for this is the housing market, right? Housing is completely bombed out because mortgage rates are 7%, uh, and, you know, there, there's no indication of that turning around anytime soon.

Um, but, you know, to, y- you will see other parts of the economy, uh, take some strain from this rise in, in rates.

I don't think we're yet at rates that obviously significantly impair the AI investment itself.

That might require rates to go long-term, borrowing costs to go even significantly higher from here, say six handle or something.

What, what are your views of her?

Is it like live, live, Krishna? Like kind of live?

No, for sure it's live-live.

Now, unlike the market, I haven't yet crossed over 50%, but it looks at least close to 50-50 to me at this juncture.

The really important thing, I think, was Walsh saying, on the one hand, here's my test for rates.

I need to be confident that underlying inflation is heading back to target clearly and at a sufficient speed.

That's a pretty strenuous test.

And then pairing that with his language where he says, look, the summer inflation data was better, but it has not changed his assessment meaningfully of the underlying inflation trend.

Has the bond market already not only made up its mind, but made the move for the Fed?

Krishna, the key question for you is, I think it would be fair to say that although markets no longer expect rate cuts, can REIT managers still create value even if rates remain structurally higher? Perhaps Krishna, if you could take us through your latest report, just walk us through some of the salient points there, please.

Yeah, thank you, Sanyal, for having me and good day to all our guests.

So as you rightly pointed out, I think our house view also is in line with what you stated that probably the interest rates are not going to go down further.

But suffice to say, I think REITs, the sector as overall, will see sort of cumulative benefit of the lower interest rates kind of getting priced for the second half.

And going into the next year, even if interest rates were to rise, we see that it is coming on the back of higher GDP growth.

And once you have a higher GDP growth, this is positive for repricing of the various leases.

And as you know, the REITs, the leases that they are in place, these have a term to maturity.

Now, finally, where can investors genuinely find value still today? If you were constructing a fresh REIT portfolio today, would you still begin with the traditional blue chip names or has the opportunity actually shifted towards the less loved REITs trading at deep discounts?

So I am curious how you think about the lasting impact there on inflation.

So I think you've really put your finger on it there because, you know, I think it is on the face of it pretty reasonable to say, look, you know, tariffs impacts probably already peaked.

That looks like it's rolling over oil thanks to the deal and oil prices moving lower.

That wave will still feed through a bit to core inflation, but it should peak around Q3, roll over maybe, you know, starting to roll over by late Q4.

So the focus, I think, should be absolutely on these cost spillovers from AI CapEx.

Now, they're different from the others.

Why? Well, first, this is coming from the demand side rather than the supply side.

What do you think the narrative will be for central banks around the world regarding hikes?

What do you think would, would cause additional trouble?

Well, look, I think in the end, uh, the hurdle for the Fed, uh, not cutting is, is, is pretty easy, right? They can just sit tight.

I think the hurdle for the Fed moving to a hike is still quite high.

I think you would need evidence, not just that, you know, y- y- you weren't getting the immediate near-term progress that you'd been hoping for on inflation.

You'd need to get the sense that this oil inflation coming on top of the tariff inflation with the boost from AI CapEx cost spillovers was starting to infect the underlying inflation process, then perhaps infecting expectations and/or wages, and perhaps seeing indications that the economy itself is starting to overheat under the CapEx boom.

I'm not seeing those conditions met right now, which is why I still think even now it's between hold and cut in the center of the distribution.

... ultimately, but, but inflationary maybe here.

So, uh, you're really, I think, spot on in wanting to focus on that issue, 'cause that presents, I think, a, you know, a, a different set of questions than the, you know, the really important but fairly standard questions about, you know, will oil prove to be a one-off, or will it seep into, you know, underlying prices, wages, expectations? I- i- in terms of thinking about the underlying dynamics of the economy going forward, it's complicated, because you're getting two very different stories on the labor side and on the other input side.

But I guess the implication of what you just said is it might not matter a whole lot.

In the near term, let's say next quarter or two certainly and, and plausibly beyond that, there isn't a live debate, uh, about changing the policy rate in the US.

I think it's very clear that with the oil inflation shock coming on top of all the prior inflation shocks, including the tariff shock that's only now cresting, the Fed is going to be firmly in the mode of policing, uh, inflation developments at least here through the end of the summer and potentially long beyond that, before they can return to any consideration of the case for rate cuts.

At the same time, I think they're very, very far away from contemplating any serious consideration of a rate hike.

So the next few Fed meetings simply aren't live, and what happens around Iran, the war, energy, and the economic data is really in the driving seat.

But I think it still matters what position the new chair is starting to set out, and I think he is setting the foundations for making the case potentially later this year to shift from backward-looking policing of current inflation shocks to forward-looking monetary policy with rate cuts motivated by an expectation that AI and technology more broadly will raise the potential growth rates of the US and reduce inflation pressures going forward.

So I think what we're seeing here is that Walsh recognizes for the time being there is no debate about rates.

If we imagine that we're in a world in a day's time, people are listening, and he said that he's going to stick around at least for a bit, does that change the first few months of, of Walsh's tenure, do you think, significantly?

So do you think inflation is going to, uh, come into line enough that the Fed can tolerate it and, and, and bring rates down?

So I think the way it works is like this.

Uh, given that the most recent labor data has provided some reassurance that the labor market is not as fragile as some thought, uh, a short while ago, the Fed will basically, uh, spend the next six months or so policing the oil price shock, making sure that it doesn't seep into core inflation in more than a minor way.

There will always be some bleed through.

Make sure that it doesn't contaminate inflation expectations.

Make sure it doesn't start to show up in stronger wage bids.

If that's right, then later in the year, they can come back to considering whether conditions are, are lining up for cuts.

Yeah.

"On the question of whether I will continue to serve as a governor after my term ends and after the investigation is over, I have not made the decision on that yet." What's the value of putting that out there?

Well, I think you're absolutely right that that was a very strong statement by Powell.

And as you'll recall, uh, it wasn't something he was forced to say because of questioning.

It's something he volunteered.

He had it written down.

He knew he wanted to say that.

Look, um, there is, there's a sort of narrow sense in which we can interpret that in a wider sense.

Are we marking another period which is sort of setting off a new era for central banks where they have less power, where frankly they don't necessarily drive the bus, where generation QE, as Michael Hartnett just said, is over?

What are you now assuming, uh, are going to be the impacts and, and how the market, uh, is likely priced for those?

So given what continues to be substantial uncertainty for how long this conflict lasts and how long the flow of energy through the straits remains de facto shut off, I...

You know, we find it helpful to think in terms of two different scenarios, a kind of baseline case in which this wraps up soon enough for oil prices to decay down to about 70 bucks by the end of the year, but we're still putting some meaningful weight on an upside risk case in which this conflict drags on further, uh, the straits stay closed for longer.

And even if that's, you know, more of a th- 40-day episode than a s- 25 to 30-day episode, uh, we think that that would leave a much bigger imprint on oil prices late this year, maybe 85 bucks at the end of the year, and therefore a much bigger consumer impact because, of course, what really matters here is less the peak price and more about how long energy prices stay elevated.

That should certainly help offset it, not to mention a pretty overall benign environment for consumers.

Oh, 100%.

So, uh, I think the question is, like, you know, against what baseline are we, are we doing this, right? The consumer is still gonna get a boost, uh, a meaningful boost from one big beautiful bill, uh, tax refunds, reduced withholding.

The question is, how much of that is knocked out, uh, by, in effect, what we're, we're calling the gasoline tax, right, the increase in the gasoline price? Let me give you some numbers.

So how do you see that, and are you concerned about it?

Right.

Yeah.

So first of all, just for your listeners, the Fed's made a bit more progress bringing down the balance sheet from the, from the peak around, I think, as you said, was it nine trillion? We're down about six and a half trillion at this point.

That's an appreciable reduction.

And in terms of the ratio of the central bank balance sheet to nominal GDP, which is... or banking assets, which is a sort of a, a kind of reasonable benchmark, you certainly unwound the pandemic expansion in the balance sheet, so that part at least has round-tripped.

But you're absolutely right that if we're looking for one consistent theme across Kevin Warsh's career, it's that he favors a smaller, cleaner, and I would add, humbler central bank balance sheet.

Do you agree with that?

Where are we here? Is this time different?

So look, I think investors reasonably continue to have a baseline in which we will end up finding a compromise, an off ramp, and we will not go through the proposed trade escalation.

I think that's the right base case.

More than that, I think it's not a 55% probability.

I think it's higher than that, right? It's a good solid base case, but it's not a certainty.

And I think what we're seeing in markets is a clear indication directionally of what happens if we continue to push down this route.

It is risk off, but dollar lower, not higher, because of increased global aversion to U.S. assets requiring a higher compensation, some U.S. risk premium to invest in the U.S. And of course, as you noted earlier, yields moving up, not down.

I just wonder if it behooves an investor to actually start to think in these tectonic terms.

Just for context, how unusual are those kinds of disagreements?

So you're certainly right to say that it's not normal to have two dissenters on one side wanting no cut and one dissenter on the other side wanting a double-sized cut.

So this is not normal.

But relative to where we were a few weeks ago where it looked like the Fed committee was splitting right down the middle and you could have three, four, even five dissenters, uh, if Powell pushed through a rate cut, the committee looks just a little bit less divided in this moment than was feared.

But certainly, there are deep disagreements on the committee about how restrictive their monetary policy still is and about the balance of risks that they're obligated by law to look at, the risks to employment on the one hand and inflation on the other.

And I think the truth is that these-... differences of economic analysis have been amplified by the political pressure on the Fed and the perception among Fed officials that their independence is under pressure.

And this is something that doesn't make it easy to come to the middle.

Has anything that you've seen tell you about who that next pick might be and whether or not President Trump's pressure campaign for deeper cuts could work?

And if that's the case, Krishna, then how does that filter into what the Fed's going to do next year and perhaps what it ought to do after we get this cut, presumably next week?

Right, so in the very near term, I think this negative ADP print might temper just a little bit at the margins, the hawkish side of the hawkish cut we expect to get next week.

Now, when we say hawkish cut, what we mean is they'll deliver the cut with near certainty, but a power will indicate that they've now completed the series of preemptive risk insurance cuts that they flagged back in September.

And then from here, policy will be data dependent but in a more traditional way that, you know, if the debt is worse than expected in a material way, then they would cut, but not otherwise.

I think they'll just temper that message just a little bit in light of this weakness.

It could also mean that you get maybe one less dissent, right, than you would have gotten otherwise.

It's the kind of number that might get Sue Collins, for instance, from Boston.

Krishna, does your policy outlook, your rate path outlook change based on who gets the top job to replace Powell?

What do you make of the volatility lately and whether or not, whether it's Bitcoin or some of the chip-related names, AI-related names, you think valuations are becoming a real concern? And doesn't that kind of collide with the Santa Claus November seasonality we are expecting?

So, yeah, for sure, there's a big tension here between the classic seasonal dynamics and the concern that even if you really are a buyer of the big AI theme, the valuations run a lot and we may need to digest before we can push on, maybe even take some profits and always with some risk that that becomes a bigger drawdown.

Obviously, as you guys have highlighted, another component here is that that Fed December cut, less certain.

than it looks.

We still think it's a 65% type probability.

But my view is that the way this places thing trades internally at Buffett is that they do one more cut, but then they signal that they're taking a timeout in early 26.

And I don't have another cut until the new guy is in as chairman at the first meeting in June.

Where do you think that nets out?

How are you understanding what's going on there when you're talking about government jobs and how that may be impacting the labor market right now?

So you're absolutely right that in addition to the sort of underlying, if you like, private sector labor market dynamics, we have to keep a very close eye on what's happening with federal and state and local employment.

So actually on the federal side, there's actually two things going on, of course, because as you know, we're waiting for the lagged effect of the Doge layoffs, those negotiated severances, to hit the data over the next couple of prints.

on the labor market side.

So there's a lagged effect we already know is in the pipeline there.

Then on top of that, we're going to see the furlough effects.

And of course, those, you know, are going to affect the potentially create some noise around the unemployment rate.

When is that one time?

Is there a chance that that reading is firmer than expected and would cause the Fed to reshape, I mean, rethink the policy?

So there's absolutely the possibility that that print could come in hotter than expected.

I have to say, I've been anticipating that at some point in the kind of fall, we would probably see a hot month or two.

It could just be lumpy pass-through of tariffs, right? So one would want to interpret any single month's data with a degree of caution.

Really, what you want to look at is the cumulative picture that's emerging over several months.

And that's the key to understanding the Fed implications, right? The ship has sailed on an October cut, almost regardless of what that next inflation print has to say, really because one print does not a trend make.

And of course, because the Fed has not gotten the reassurance they would like to see that this labor weakening is remaining a moderate, mild weakening and not starting to accelerate into something more worrisome than that.

So how do you explain what we're seeing in the job market right now? Because as I mentioned earlier, there's a lot of resilience and obviously GDP spending has been on fire with AI and investment in America, but consumers held up, but the lack of job growth, but also lack of firings, we don't know what's happened the last few weeks because we don't have jobless claims, but how do you explain that? What's happening there?

I mean, at what point is this market not appreciating how hot this Fed is already running the economy?

So, I certainly agree with you, that this is a quite unusual set of circumstances.

I think it's important to caveat that in two ways.

First, the Fed is not cutting rates, to, at least under Powell, is not contemplating cutting rates to what the Fed at least would cons- -ider stimulative territory.

What they're talking about is removing what they estimate to be the remaining restraint in the economy, that's the roughly 75 basis points of restraint between where we were on the eve of the September meeting, and a spot neutral setting that might be in the ZIP code of three and a half, three and three quarters, separate from where the long-term, uh, neutral rate li- lie when things settle down to equilibrium, which m- many still see at the Fed as more like 3%.

So, you're talking about removing restraint, not providing stimulus.

The other thing is, of course, you're seeing, I think, under Powell's leadership, and of course with, er, pressure, intellectual pressure from Waller and one two others, are the Fed's tr- taking a view that maybe they should be, at least to some significant degree, looking through that current elevated inflation, because it's, to a large extent, reflecting the pass-through of tariffs into prices.

Will that help housing affordability? Will that help with this sort of declining trend in inflation that is hinged to the housing market, frankly, er, which has kind of gotten slack?

So what are your predictions on those fronts?

Well, so first of all, I mean, you're absolutely right that the Fed is still engaged in this balancing between the labor risk and the inflation risk.

And they're not locking their hands and saying you're guaranteed to get these cuts.

But the importance of yesterday, why it is fundamentally bullish dovish for markets, is that they're saying that the default is going to be to cut three times because of the current assessment that labor risks are rising and inflation risks may be coming off a bit.

So you need the new information coming in over the balance of the year to really fundamentally challenge that, overturn that assessment, not to deliver the two more cuts.

What would that look like? Like, you know, obviously much stronger payrolls.

Oh, no.

What do you think it ultimately is going to mean for the path of inflation? We're sort of talking around it and emphasizing the labor market more, as the Fed has, but how do you see these tariffs coming through?

Do you agree?

I think what's important here is that the inflation that we really care about is the second-round inflation.

It's the risk of inflation persistence.

And no one, as a matter of theory or practice, thinks that the central bank should be directly responding to the first-round effect of tariffs like a tax mechanically on prices.

The issue is, what pressure does that, if any, impart to underlying inflation dynamics? That's the second-round question.

And so I'm less focused on the individual month's inflation pass-through from tariffs, that's the first-round mechanical stuff, than I am in trying to assess, uh, what the risks are of inflation persistence and balancing those against the risks to the labor market.

I actually think the conditions likely have been met for an initial cautious step down towards a more neutral rate.

Well, what if the Fed didn't, Krishna, take the time it needs? What if the Fed, um, wasn't as thorough? What if the Fed was stacked with Trump appointees who just wanted to do the president's bidding? Um, would you buy them 10-year Treasuries? I mean, does 420 make sense to you?

But what do you think the potential is for a surprise on Friday either way?

Well, I mean, you can see from how wide the estimates are, right, that the honest answer is that people who, you know, spend a lot of time trying to figure this out, see a lot of uncertainty as to where the labor market's going to print this Friday and again, you know, this next month as well.

Now, I think that's why the Fed is in wait and see mode, right? They don't want to just see data from June.

They want to see data from June, July and August and then make that call on rates.

I think the picture up to this point has been labor market aggregate, pretty solid, but with some softening under the hood.

And in that last employment report, of course, hints of private sector hiring, particularly outside of those non-cyclically sensitive health and education sectors, the private sector hiring is quite weak.

If we get that private sector weak hiring theme, confirmed in Friday's print.

Is that getting talked about?

But what kind of soft guidance do you think he might give about the fall?

Look, I think that the Fed's going to stay very much in wait and see mode today.

Now, we've had some interesting data come in, right? The top tier data for May, pretty reassuring, right? The labor market, unemployment, payroll gains still looking pretty solid.

An inflation report that was good, surprisingly, didn't show inflation pressures from tariffs even in goods.

So, so far, so good.

But as you guys know, housing starts, the wider retail sales, some softness here and there.

And I think the real point, as far as the Fed's concerned, is it's just very early days.

Is there a risk that the Fed is too late when it comes to cutting?

How much is that almost more important than the rhetoric that we hear out of the Fed right now?

So I think you're certainly right.

First of all, you know, the real action here is on the Trump economic agenda, above all trade, but also immigration, fiscal, you mentioned, you know, regulatory, other policies.

And the Fed, to a large extent, is responding to those shocks.

and learning from the economic data how they are impacting economic activity.

So, yes, you know, the Fed is going to take its cue from, first, the path of policies like trade policy.

Secondly, how this is built in through the macro data, the market data.

Is there a level on the two-year yield down where you'd say, okay, the Fed is now behind the curve and kind of needs to get back in the easing cycle maybe faster than you thought?

How much is that almost more important than the rhetoric that we hear out of the Fed right now?

So I think you're certainly right.

The first of all, uh, you know, the real action here is on the Trump, uh, economic agenda, above all trade, but also immigration, uh, fiscal you mentioned, you know, regulatory, other policies.

And the Fed to a large extent is responding to those shocks and learning from the economic data how they are impacting, uh, economic activity.

So yes, you know, the Fed is going to take its cue from, first, the path of policies like trade policy.

Secondly, how this is filtering through the macro data, the market data.

But it does matter what reaction function the Fed is sketching out that it will apply in these different economic circumstances.

Can you talk just for a moment about kind of this divergence between the market rate and the policy rate? We've always joked in our work that who needs Fed speakers when you have the two-year yields? Is there a level on the two-year yield down where you'd say, okay, the Fed is now behind the curve and kind of needs to get back in the easing cycle maybe faster than you thought?

Are investors too complacent?

So I'm not sure investors are complacent, but I think it is clear that the market is not at this point discounting odds on for a full scale war.

The market is pricing a more limited series of engagements and some risk of escalation into a full blown conflict.

In particular, as your previous guest has just noted, We haven't yet seen actions that directly target oil.

We haven't seen the Israelis strike major Iranian oil installations.

We haven't seen the Iranians threaten to or attempt to either strike Saudi or Gulf facilities or, which was always the most feared action, try to close the Straits of Hormuz.

So right now, the market is treating this as an engagement that is more serious than those short tip for Ted episodes that preceded it, but that is probably not going to escalate into full scale conflict.

So in a world where we already have these tariff turbulence moments in 2025, how does this affect the global picture as you see it for risk? Is risk particularly more pronounced now, Krishna, in some places versus where it was before? Or is it too soon to make any shifts in your calculations and what you expect might happen?