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Hidden Forces

What the Fed’s Rate Decision Will Mean for Markets | Andy Constan

Wed Jun 14 2023

The Hidden Forces podcast

  • The podcast features guest Andy Constant, founder of Damp Spring Advisors.
  • Andy's perspective is quantitative and flows-based, looking at what policymakers and investors are doing rather than just saying.
  • The podcast discusses the big news week in markets, including inflation numbers, the Fed's interest rate decision, initial jobless claims, and retail sales numbers.
  • The second part of the conversation focuses on scenarios for the FOMC's rate decision and its implications for bond prices, equities, inflation, and economic growth.
  • Listeners can access the second part of the conversation by joining Hidden Forces' Premium Feed or becoming a member of their Genius community.
  • Nothing said on this episode should be viewed as financial advice.

Andy Constant's background and approach

  • Andy worked in sales and structuring for Solomon Brothers and ran their global business.
  • They started a hedge fund for relative value trading with fixed income traders from Solomon Brothers, but the partnership fell apart after four years.
  • They joined Bridgewater to learn about macro understanding of markets and then worked for Brevin Howard to learn a different style of macro.
  • Alan Howard helped them launch Damp Spring Advisors, which helps hedge fund managers understand macro and portfolio management.
  • The speaker uses Twitter to have high-quality discourse with people who think differently than they do in the public square for the benefit of themselves and others.
  • Their investment products have a waitlist, so they are not looking to market anything anymore.
  • Their research is for hedge fund managers who want to understand macro and portfolio management.

Bridgewater's approach to understanding the economy and markets

  • Bridgewater has a team that understands how the economy works and what to do about it in markets, without any silos or economists.
  • Economists are good at understanding the economy but not necessarily markets and making money from them.
  • Portfolio managers, including hedge fund traders, are excellent at understanding markets but hobbyists when it comes to the economy.
  • The speaker's role at Brevin was to provide a holistic approach to both markets and macro due to their significant portfolio and trading experience and deep understanding of macro.
  • The speaker's unique offering appeals to a wide range of audiences, including head fund clients with about $200 billion in assets under management in macro.
  • The speaker's perspective is flows-based and focused on what is actually happening in the plumbing of the economy rather than theoretical constructions.
  • Economic models have become less useful over time, leading to an arms race where innovation and strong basic principles are necessary.

Factors influencing inflation and interest rates

  • Understanding the economy is still important, but it's necessary to have a well-thought-out and rigorous approach.
  • Simply having a flow idea or equation won't make money in markets.
  • The best people invest thousands of man hours every year to stay ahead.
  • Inflationary tailwind remains strong and will require the Fed to be higher for longer.
  • Markets are accepting this possibility, which has led to stocks rallying and bonds selling off.
  • An actual recession may be required to ensure inflation is dead.
  • Questions arise about why there hasn't been a recession yet despite rising interest rates, how high the Fed can raise interest rates before it becomes a problem for both private sector and Treasury, and why the Treasury is looking to fill TJ with higher bill issuance.

Effectiveness of interest rate hikes in the current economy

  • The Fed has done a lot, but it hasn't had enough impact on the current US economy which is more services-oriented.
  • Interest rate hikes discourage cash consumption and increase borrowing costs for capital goods, but not much for services.
  • Raising interest rates is less effective in the current economy as it is less responsive to changes in interest rates.
  • The Fed only has two levers: interest rates and fiscal policy. Interest rates may not be as effective due to supply-side factors driving inflation independently of monetary or fiscal policy.
  • In 2008, interest rates played a bigger role in fueling inflation due to adjustable rate mortgages and housing. Today, fiscal stimulus and credit guarantees by the government have played a bigger role.

Factors contributing to current inflation

  • The current inflation is due to fiscal stimulus, not monetary conditions.
  • Supply chain disruptions were real but mostly behind us, and the current inflation is going on for other reasons.
  • De-globalization can perpetuate inflation.
  • The Fed needed to do quantitative tightening (QT) in response to market responsiveness, which led to a big sell-off in bonds and stocks through June 2022 that we're now recovering from.
  • During QT, the Fed reduced its balance sheet by about $500 billion, but it's actually going a lot slower than they had planned.
  • The Treasury General account (TGA) started consistently being sued for the government infused $700 billion of spending into the economy right as the Fed was taking withdrawing $500 billion of liquidity from the economy.
  • Quantitative tightening was front-run heavily and now is really not doing much because it has been more than offset by the spending that's coming out of the treasury.

Impact of labor market and infrastructure investment on inflation

  • Supply chain resolution had a meaningful impact on inflation in the last year.
  • The labor market is very tight due to de-globalization, domestic energy investment, and duplicate supply chains.
  • Investment in these three infrastructures by the public sector generates jobs and services.
  • A tight labor market and significant savings that could be turned into consumption or investment are important inflationary impacts.
  • Coordination between fiscal and monetary authorities will play a bigger role in inflation or deflation.
  • The 3Ds create safety and insurance but not wealth creation, which generally flows through to prices.

Government intervention and fiscal policy

  • Government intervention through employment and infrastructure projects can aid in economic recovery and prevent inflation.
  • The Fed plays a role in stabilizing the economy, but fiscal policy has a larger impact.
  • The government may use credit guarantees and incentives to direct investment towards specific areas of the economy.
  • Demographics, technology-driven deflation, and geopolitical shifts can all impact long-term inflation trends.
  • Investors should aim for balanced exposure to all possible outcomes rather than betting on specific predictions or beliefs about the future.

Risk premium and investing

  • The podcast discusses the concept of risk premium and its importance in investing.
  • Risk premium is the excess return an investor receives for taking on risk when buying an asset.
  • Assets with positive expected values have a higher risk premium, but other factors can influence their returns.
  • The demand for an asset affects its risk premium, with high demand leading to lower expected returns.
  • The discussion also touches on the correlation between the decline in risk premium and the rise in equity prices, as well as the inversion of yield curves and impending recessions.

Monetary policy and balance sheet considerations

  • The more people want an asset, the lower the risk premium.
  • If bonds get bid up, sellers may buy equities instead to maintain a positive expected return.
  • Risk premiums must be equal across all assets for money to flow evenly.
  • There has been a lesser impact of quantitative tightening and aggressive pricing by fixed income investors expecting rate cuts and a recession, resulting in a very low risk premium across all assets.
  • This has translated into higher equity multiples but is not necessarily worthy of investing cash.
  • The size and composition of the Fed's balance sheet versus the duration of its assets is an academic discussion with two schools of thought: stock (size and composition) and flow (shrinking or expanding balance sheet).
  • The speaker believes in the flow school of thought.

Monetary policy transmission and reverse repo facilities

  • The composition and duration of the Fed's balance sheet is important to consider in terms of monetary policy transmission.
  • The Fed's choice to buy 30-year bonds versus two-year bonds affects the level of risk in the private sector.
  • The Treasury's decision to issue more bills instead of bonds may be due to the high demand for T-bills and their low risk.
  • The SLR rule change in March 2021 affected bank profitability and led to a flood of deposits into the market, which had to be moved outside the banking system through reverse repo facilities.
  • The Fed opened its reverse repo facility (RP) to allow people to move their deposits to money market funds, which could then hand the cash to the Fed and earn interest.
  • This eased pressure on the banking system and allowed the Fed to control interest rates.
  • Money market funds want bills because of regulatory requirements, but went to the RRP because bill rates were lower than RRP rates.
  • Interest paid by the Fed reduces the amount of money it can hand over to the treasury as income from its activities, meaning taxpayers are paying a high rate of interest regardless of whether there are bills issued or not.
  • Tapping money from the RRP has a mitigative impact on liquidity and inflationary goals compared to using deposits from the banking system for new bill issuance.
  • The RRP has virtually no impact on markets if bills are funded by it, but if not, banks may have to create money for new bond or bill issuance.

Treasury bills and bonds and their impact on liquidity

  • The banking system is the only other source for treasury bills and bonds besides the Fed.
  • Banks pass their deposit reserve to the Fed when buying a bond or bill for themselves or their clients.
  • A bank run can cause banks to lose deposits, but the system itself doesn't necessarily lose deposits.
  • Money leaving the banking system exits proportionally from strong and weak banks in a "bank walk."
  • Reserves are important for the banking system, but failure to tap RRP may have minimal impact on liquidity.
  • Issuing risky coupons has a bigger impact on liquidity than tapping RRP or hitting bank reserves.
  • The Treasury issued mostly bills instead of coupons to avoid marginally impacting long-term bond yields.
  • The summary of economic projections and J-PAL statement at the press conference are important for predicting interest rate decisions.

Podcast details

  • The podcast is listener-supported and does not have any commercial sponsors or advertisers.
  • Listeners can access the second part of the conversation with Andy by subscribing to one of three content tiers on
  • The episode was produced by the host and edited by Stiliano Nicoleau.
  • More episodes can be found on, and listeners can follow the host on Twitter @Kofinas or email