PodcastBanklessJim Bianco

Why Higher Rates Could Actually Calm Markets

The discussion examines whether a more independent, data-driven Fed could keep rates higher while ultimately calming bond markets, despite persistent inflation, funding-market constraints, and uncertainty over future votes. It also considers the scale of AI investment, its effects on computing capacity, inflation, and equity risk, alongside crypto's potential role in dollarization. Market examples—from the 2013 taper tantrum to repo stress and rising long-term yields—frame the debate over balance-sheet policy, while forecasts point to possible rate hikes, delayed quantitative tightening, and an AI cycle that may remain inflationary until around 2030.

Interest RatesMonetary PolicyInflationMarket VolatilityArtificial IntelligenceCrypto Markets

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Key Takeaways

The Fed is portrayed as increasingly driven by 12 independent voters rather than a chair-led institution: at the July 29 meeting, three officials favored a rate increase and nine opposed it. The guest favors a reaction function that explains which data would trigger a hike, hold, or cut instead of forward guidance that markets may treat as a promise.

Persistent inflation is central to the guest's rate outlook: inflation has remained above 2% for 64 months and is currently around 3.4%, while he questions the timeliness of payroll data and places greater weight on inflation. He estimates roughly 40%–50% odds of a September hike and argues that sustained 3%–4% inflation could justify rates near 5%, with some rates potentially closer to 6%.

The episode links Fed policy uncertainty to unusually volatile long-term bond markets. Despite 175 basis points of Fed cuts, the 10-year yield was roughly 95 basis points higher and the 30-year yield about 1.25 percentage points higher than in September 2024, while the guest expects future meetings could produce hike probabilities between roughly 33% and 66%.

The guest argues that balance-sheet reduction is constrained by the combination of rising federal debt and relatively small funding markets, which have relied on the Fed for liquidity. The 2013 taper tantrum, when the 10-year yield rose 140 basis points in four months, and a prior repo episode that pushed rates to 9% illustrate the risk he associates with reducing the balance sheet too quickly; he expects meaningful QT may be delayed until the second half of 2027 or 2028.

Inflation poses a direct risk to bond investors because it erodes fixed cash flows, and bond selling can push prices down while yields rise; the 30-year yield is cited at 5.2%, near a 19-year high. The guest nevertheless notes that higher yields are not automatically bearish for equities, since stocks recently reached an all-time high even as the 30-year yield reached that high level, although excessively high rates could choke off the economy.

GEO-POLITICS

Fed Independence — The guest argues that the Fed's move toward greater independence began as protection against a president seeking to appoint loyalists and direct board votes. Kevin Warsh was comfortable with the resulting internal debate.

“I think it started off as to protect the institution against a president let's write it general a president it's Trump now it could be a future president that wants…”—

TECHNOLOGY

AI Capex — AI investment is unusually large: Alphabet's projected $190 billion in capex exceeds Russia's planned Ukraine-war spending, while hyperscalers' combined $1.2 trillion exceeds the Defense Department's budget. The guest says the constraint is insufficient computing capacity, not excess capacity.

“Alphabet Google's capex this year at $190 billion is more than Russia is going to spend on the Ukraine war. And all the hyperscalers at 1…”—

AI Platform — The guest argues that AI could transform knowledge work by allowing one instruction to coordinate tasks currently spread across separate software applications.

“AI will do that for us. That's why I think we're going to see such a big transformation in this…”—

ECONOMY

Fed Voters — The Fed is increasingly described as 12 voters rather than a chair-led institution. At the July 29 meeting, three officials favored a rate increase and nine opposed one; Warsh prefers persuading officials rather than dictating their votes.

“What the Fed is starting to wind up being is 12 independent voters. And so we've seen this now…”—

Reaction Function — The guest favors replacing forward guidance, which markets may treat as a promise, with a reaction function explaining what data would lead to a hike, hold, or cut.

“Why? Because too often the market takes forward guidance is a promise.”—

Sticky Inflation — Inflation has been above 2% for 64 months and is currently around 3.4%. Warsh is described as placing more weight on inflation than employment and questioning the timeliness of payroll data.

“inflation has been above 2% for 64 months ever since the Zera. It's been really sticky at 3 to 4%. I think we're at 3…”—

MARKETS

Taper Tantrum — The 2013 taper tantrum showed how unexpected Federal Reserve balance-sheet changes can reprice bonds: the 10-year yield rose 140 basis points in four months.

“And then in May of 20 2013, he comes out of the blue and says, "We might change the size of the balance sheet. We might reduce it…”—

Yields Defy Easing — Although the Fed cut rates by 175 basis points, the 10-year yield was roughly 95 basis points higher and the 30-year yield about 1.25 percentage points higher than in September 2024. The guest says this is unprecedented in his 55-year dataset.

“The Fed cut rates by 50 basis points. That was their first rate cut. And they've cut rates six times for 175 basis points.”—

Repo Stress — A funding shortage previously drove the repo rate to 9% and caused havoc on Wall Street. It illustrated the market risk of reducing the Fed's balance sheet too quickly.

“When they started to reduce the balance sheet, what they said was, "We're going to get out of the business of funding Wall Street."…”—

FORECASTS

Fed Market Uncertainty — The guest expects many future Fed meetings to show rate-hike probabilities between roughly 33% and 66%. That could make markets more cautious and positioning more dependent on independent probability assessments.

“And get used to that because I think every meeting as we go, not every meeting, but most of the meetings, if you look at Paulie or if you look…”—

Lower Long Yields — The guest argues that a more forceful Fed response to inflation could calm the bond market and cause long-term yields to fall even if short-term rates rise.

“Maybe if the Fed panicked a little bit about inflation, then the bond market would calm down and you'd actually see falling yields.”—

Higher Rate Path — The guest estimates roughly 40%–50% odds of a September hike. He argues that persistent 3%–4% inflation could justify rates near 5%, with some rates potentially closer to 6%.

“And that's why the odds are like 40 40 50% right now on the September meeting because that's kind of where we're where we are with this Fed.”—

A New Fed Takes Shape

The Fed is becoming a body of independent voters rather than a chairman-led institution, with dissenting votes and uncertain meeting outcomes making every governor more important.

Warsh's Good Family Fight

Warsh accepted the Fed's emerging independence as a constructive family fight, while Trump and Treasury Secretary Scott Bessent favored his forceful personality over Kevin Hassett's more academic style.

The End of Forward Guidance

The speakers argue that forward guidance can trap the Fed into bad policy, citing the 2021 inflation mistake and the 2013 taper tantrum, while debating whether the Fed should publish clearer reaction functions.

Markets Learn to Price Ambiguity

Less guidance means markets must price probabilities and ambiguity instead of relying on promises, reducing leverage-driven blowups while forcing investors to respond more directly to economic data.

Why Rate Cuts Raised Long-Term Yields

Despite substantial rate cuts since 2024, long-term Treasury yields rose because bond investors judged the Fed insufficiently concerned about inflation; credible tightening could therefore calm the long end.

Inflation Changes the Vote

Persistent inflation above the Fed's 2% target is increasing the number of officials prepared to hike, making inflation more important than employment and pushing expected policy rates toward five or six percent.

Rates or Balance Sheet?

Rate hikes are immediately available, but balance-sheet reduction requires changes to funding-market rules because earlier quantitative tightening contributed to repo stress and could again destabilize short-term financing.

The Case for Higher Rates

Moderately higher rates could reassure bond investors that inflation will be contained, while appropriately priced money can support equities and discourage speculative or economically unproductive investment.

AI Capex and the Economy

AI investment is already a major economic force, with hyperscaler capex rivaling national defense budgets and data-center construction supporting employment, infrastructure demand, and higher rates.

Warsh's AI Deflation Bet

Warsh expects AI's eventual productivity gains to create disinflation, but the guest believes the transition will first require years of expensive construction, scarce chips, and inflationary demand.

The Bubble Comes Later

AI is likely to produce a large bubble eventually, though the speakers disagree about timing and severity; the technology may resemble the late 1990s, with substantial gains followed by a painful correction.

Gold, Bitcoin, and Debasement

Gold and Bitcoin are not currently expressing a straightforward debasement trade, while crypto's strongest opportunity lies in dollarizing unstable economies through stablecoins and building alternative financial infrastructure.

Strong Crypto vs Weak Crypto

The speakers distinguish strong, permissionless crypto from weak crypto subordinated to banks and regulators, arguing that the industry must return to cipherpunk principles rather than merely attract institutional capital.

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Important Disclaimers

Not Investment Advice: For education only — not financial, tax or legal advice.

AI-Generated: Made by AI from source transcripts and may contain errors.

No Guarantees: Past performance does not predict future results; investing carries risk.

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