Expectations Versus Reality in the Inflation Food Fight
Who are these people and how stupid do they think we are...
Dear Fellow Traveler:
So... Federal Reserve Vice Chair Philip Jefferson gave a speech in Kansas City.
He blamed the Fed’s failed attempts to bring inflation down... on tariffs.
Is there anything they can’t do?
Then he admitted repo rates are rising in ways the Fed really doesn’t like.
Then he said the Fed’s balance sheet runoff is over.
Then he said the standing repo facility is being tapped more often.
Then he said the labor-market data he relies on is missing because of a government shutdown.
Other than that, everything is great.
He should have said: “Our house isn’t on fire. Also the fire alarms are broken. But things should return normal soon. Maybe. Trust me.”
Let’s look at the optics of America’s favorite “BRRRRRing” Family…
What Everyone Thinks Is Happening (Expectations)
If you believe the Federal Reserve…
Here’s the official story. Carefully manicured. Probably focus-grouped with people who have never opened a math book or seen a balance sheet.
Jefferson delivered “measured remarks” about the economic outlook in Kansas City.
The Fed’s process of rolling off its balance sheet will end in December. They are doing this because banking reserve levels have reached appropriate targets (or so they claim).
Now they’ll start adding liquidity back into the system.
But be aware.
It’s not Quantitative Easing. It’s “Reserve Management Operations.”
Not stimulus.
Now he says tariffs are temporarily disrupting inflation progress, but excluding those effects, we’re still heading toward 2% - the official target…
Plus, he says that labor markets are cooling gradually.
Everything is proceeding according to plan.
Just routine central banking.
Technical adjustments. Nothing to see here.
What Actually Happened (Reality)
Here’s Reality…
The Fed just announced it's restarting operations that are mechanically similar to QE on the reserve side, but using short-term bills, while swearing on a stack of FOMC transcripts that it’s definitely not QE.
Here’s what Jefferson revealed, if you know how to translate Fed-speak into English.
They’re flying blind with broken instruments.
Jefferson admitted the government shutdown killed the data he needed.
No monthly jobs report. No inflation data. Multiple federal datasets are offline.
So now he’s making monetary policy based on anecdotes and business leader connections. This is like a pilot landing in fog using passenger complaints about turbulence to judge altitude.
They broke the repo market and had to stop QT. Buried in Jefferson’s speech was the real confession. Repo rates traded persistently above the Interest on Reserve Balances (IORB).
That’s the canary in the systemic liquidity coal mine.
The Standing Repo Facility took a beating on Treasury auction days.
The fed funds rate started drifting higher.
Why?
They drained too much liquidity, money markets started seizing up, and they had to hit the emergency brake before September 2019 happened all over again.
The tariff excuse is theater and stalling. Boston Fed has shown tariffs add 0.3–0.8 percentage points in one-time effects.
Jefferson blamed the stalled inflation progress on tariffs. But tariffs create one-time price level adjustments, not persistent inflation. You don’t get sustained 3% inflation from Argentine beef tariffs. You get it from systematic monetary expansion, labor market distortions, fiscal policy excess, and housing policy failures.
But blaming tariffs lets them avoid admitting their policies are failing.
Meanwhile, the labor market looks bad. Jefferson claimed labor markets are cooling gradually while admitting he can’t see the data. Meanwhile, private estimates for long-duration unemployment just hit 4.92 million people, the highest level since early 2021, according to MishTalk.
That’s not gradual cooling. That’s structural deterioration that shows up in the unemployment claims data if you know where to look.
This is all Expectations Versus Reality… (great movie scene, by the way)…
But instead of falling in love with Zooey Deschenel, we just walk home crying…
The Semantic Nonsense
Here’s where this whole charade falls apart.
The Fed is simultaneously claiming that inflation is stuck at 3% and needs to come down.
Monetary policy must remain restrictive to achieve this.
But they’re about to inject hundreds of billions annually into the banking system through Reserve Management Operations that definitely won’t be inflationary because they’re calling it maintenance in” instead of QE. (HA)…
How stupid do you think we are?
Every reserve dollar they create expands lending capacity, eases financial conditions, boosts asset prices, encourages risk-taking, and weakens the dollar.
These are the exact transmission mechanisms that create inflation. But apparently, inflation doesn’t notice if you call it maintenance instead of quantitative easing.
The mechanics are identical to QE.
It’s the same transmission channel.
Reserves created, securities purchased, liquidity injected.
Money goes from the Fed to primary dealers to the banking system.
Bank reserves increase.
Duration gets removed from private hands.
Liquidity conditions ease.
But they’re calling it Reserve Management Operations instead of QE, so somehow it’s totally different.
No One Buys This
Markets understand plumbing better than Fed communications teams.
Repo traders don’t care what Powell calls it.
They care about collateral scarcity and balance sheet elasticity. (Say that 10 times fast)…
This isn’t $20 billion to $30 billion and done.
Currency in circulation grows roughly by tens of billions a year…
Bank balance sheets expand by hundreds of billions…
Watch the Treasury inject over $100 billion through the General Account…
By the time it’s over, the Fed will have pumped about $300 billion to $400 billion into the system to offset reserve challenges....
That’s not maintenance.
That’s monetary expansion disguised as technical operations.
Duration gets systematically removed from the system.
Every Treasury bill they buy is a duration that hedge funds, dealers, and asset managers don’t have to hold.
That capital flows into longer-term Treasuries, corporate credit, equity markets, real estate, and commodities.
The yield curve steepens, spreads compress, and risk assets rally.
The dollar weakens on the reality of an easier policy.
Foreign exchange markets see through semantic games better than anyone.
More Fed balance sheet expansion equals sustained dollar weakness, regardless of what Powell calls it in press conferences.
The Positioning
So… when it comes to the Fed’s word games.
Start paying attention to duration. Yeah, I said it.
Treasury futures, TLT positions, curve steepener trades, and long-duration bond funds all benefit from the Fed's systematic buying.
Short the dollar against real assets.
Gold and commodity exposure through energy and agriculture, foreign equity overweights, and crypto positioning all benefit from the dollar weakness that comes with balance sheet expansion.
Look at investment-grade credit. Turn to toll roads, essential infrastructure, and anything with stable cash flows that benefits from easier financial conditions.
Because in the end, the Fed just announced QE while insisting it’s not QE. They’re injecting hundreds of billions while claiming it’s maintenance.
They’re easing policy while pretending they’re still restrictive.
Markets will respond to the mechanics, not the marketing.
Position accordingly.
And share this with a friend who thinks the inflation right is going just great…
Stay positive,
Garrett Baldwin
So quick question on your stance of the yield curve steepening due to the QE that is coming. Are you saying that long durations treasuries will have higher yields due to the weakness of the dollar and increased inflation, or lower yields because as the fed buys up TBills it helps lower the rest of the curve? Basically what’s your prediction on the extreme long end of the curve compared to where it’s at now?