Host: Hello my friends. Today is April 25th, and this is Markets Weekly. Last week was another crazy week in markets. It seemed like the stock market could only go up, and indeed we did have new all-time highs in the S&P 500. At the same time, the Strait of Hormuz remains closed. Oil continues to tick higher, and we have Jared Kushner and Steve Mnuchin off to the Middle East to discuss peace. In the background, a third carrier is moving into position. I feel like I've seen this movie before.

Today, let's talk about three things. First, let's talk about what happened at Kevin Walsh's confirmation hearing last week, where he revealed his newest tactic to get rate cuts. Secondly, and related, Kevin Walsh has a narrower view of Fed independence, and that's opening up some very interesting potential uses of the dollar swap line, whereas the UAE is now requesting a dollar swap line. Secretary Janet Yellen seems to be willing to grant it. We may have a new diplomatic tool, at least a new way of using dollar swap lines that's opening up interesting possibilities. The last thing I want to talk about is the bonkers price action in these semiconductor stocks. The market seems to have come to the conclusion that we don't have enough compute, so all these semiconductor stocks are surging. Intel up 25% in a single day, finally exceeding its dotcom boom highs. Starting with Kevin Walsh, to be totally clear, Kevin Walsh is super well-connected. He is going to be confirmed as Fed chair, and it looks like he's going to be able to sit as Fed chair for the June meeting. He was nominated by the king with one job: to cut rates. Over the past few months, he's been going around telling everyone that we have this tremendous AI boom that is boosting productivity. Of course, that's disinflationary, that means the Fed can cut interest rates. Just one problem with that: when you look at the official inflation indexes, they don't seem to be going lower and actually they are ticking higher.

Host: As the trade-off remains closed, oil prices can continue to increase. If fertilizer is not able to flow, it's possible that we could have food shortages in the coming months that suggest higher food prices. So that's a big problem if you have to cut rates. So Kevin Walsh has a new tactic to get what he wants. Let's listen to this exchange between him and the Senator of Nevada.

Kevin Walsh: I think the data that's being used to judge inflation is quite imperfect data. Among the projects that the economics profession, and if I'm confirmed as chairman of the Fed, the Fed needs to do, is to try to use our new understanding and new data sources to see what's really the inflation rate in the economy. We used to use core PCE core measures, so we'd exclude food and energy because it was a rough estimate of what was going on. We don't have to do a rough estimate anymore. What I'm most interested in is the underlying inflation rate, not the one-time change in prices because of a change in geopolitics or a change in beef, but the underlying generalized change in prices in the economy. My broad sense is that these inflation risks and the inflation damage of the last several years are improving somewhat. It has improved somewhat in the last year. The measures I prefer are looking at things that are called trimmed averages, where we take out all of the tail risks, all of the one-off items, and we ask ourselves whether the generalized change in prices is having second-order effects on the economy. Again, they're not where they should be, but I think the trend is quite favorable.

Host: So what Kevin is saying is that these inflation indexes look high, but there's another way to calculate inflation. If you take out the prices that are going up a lot, inflation doesn't look so bad. Let's look at this trimmed mean PCE. It's above 2%, but just by a little bit, and it's trending lower. So maybe we could cut rates, right? This is a very common tactic by governments. Historically, for example, the CPI in the US once included mortgage rates. But as the Fed raised rates aggressively to combat inflation, that also pushed up mortgage rates, which had the unintended impact of pushing CPI higher. So they redefined CPI and took out mortgage rates. Again, if you want to do something and the official indexes aren't cooperating, redefining it is a strategy that governments all around the world and throughout time have always used.

Kevin also floated another idea: he mumbled something about the Billion Price Project collecting inflation data in a different way. For those who don't know, the Billion Price Project was very popular after the Great Financial Crisis. It's a project started at MIT to scrape the internet for all sorts of prices to come up with an alternative measure of inflation. After the Great Financial Crisis, the Fed was doing QE, printing massive amounts of money. At that time, many monetarists believed that if you printed a lot of money, inflation would go higher. These people were freaking out, gold prices were going higher, and they were telling everyone that inflation or even hyperinflation was right around the corner. The problem was the official inflation indexes didn't show it, and for the next 10 years, inflation was below 2% most of the time. To justify their philosophical beliefs, they were desperately looking for alternative measures of inflation, and at that time, it was something like the Billion Price Project, which seemed to show a higher rate of inflation, which ultimately, looking back, was also not true. So, in any case, what Kevin is suggesting is that maybe we could collect inflation data in another way, and I suspect that if he were to do it that way, he could find a way to collect inflation data such that it looked lower than the official PCE data.

Host: This guy has a heavy task of trying to cut rates, and so he's finding ways to do so. Some may say this is a committee, but at the end of the day, these people on the committee don't really have any political power, and I suspect they can be squeezed. I think the real constraint to cutting rates is the public. If we look at spot oil prices, they continue to move higher. If you look at jet fuel, it continues to move higher. So, unless the Strait of Hormuz situation is resolved, inflation is going to continue to rise. No matter how dovish a Fed you are, no matter how much political pressure you have, you won't be able to cut rates if the public is feeling inflation and becoming increasingly worried about it. That's going to be the real constraint for the Fed, even a Kevin Walsh Fed. Remember there is a path here where the Strait of Hormuz is not resolved, inflation ticks higher, and maybe the Fed has to hike rates, which would be a situation I think would be very bad for financial assets, especially since they seem to be so elevated.

Host: As an aside, another interesting exchange I found during the Kevin Walsh hearing is this one.

Senator: Would you answer my question, please? I ask if you have a hundred million dollars in undisclosed assets, and what I'm asking is, are any of those with this outfit that invests in companies affiliated with President Trump or his family, companies that have facilitated money laundering, Chinese control companies, or financing vehicles set up by Jeffrey Epstein? It's a yes or no question.

Kevin Walsh: Senator, I have worked tirelessly with the ethics officials at the office of government ethics, and you have not come to an ethics agreement and have agreed, Senator, to sell all of my financial assets.

Senator: You are refusing to tell us if you have investments, for example, in vehicles set up to advance Jeffrey Epstein? Is that what you're telling us? You just won't tell us.

Kevin Walsh: Senator, what I'm telling you is that those assets that you represent at Juggernaut will be sold if I'm confirmed before I take office and sign the oath of office.

Host: Kevin has asked about his ties to maybe investing in the Trump family or maybe with Jeffrey Epstein. I would think the standard answer to that is of course just to say no, but he can't say that, which I thought was very interesting.

Host: The second topic we want to talk about is Fed independence. Everyone, or a lot of people, are concerned that Kevin Walsh may not be independent. He may be the president's 'sock puppet.' Everyone, including the president, acknowledges that Fed independence is a sacred principle, and they cannot openly say they don't believe in an independent Fed. What seems to be happening is that Kevin Walsh is redefining what independence means such that, in effect, the Fed is becoming less independent, although parts of the Fed remain independent. In his opening statement, he openly asserts that the Fed has independence over interest rate policy. So whether the Fed hikes or lowers rates is up to the Fed, not to the president. But then he talks about other things the Fed does, for example, banking regulation, which is acknowledged even by Democratic administrations to belong to the White House. When you have a new president, that president nominates a new vice chair of supervision. That's already happened, and there's a huge deregulation effort for banking regulation. He also talks about international finance, and that has to do with the FX swap lines.

Historically, FX swap lines were something the Fed did itself, and they only came out in times of extreme emergency. For example, during the Great Financial Crisis, we had huge FX swap lines to support the global dollar system, and again in 2020. To be clear, FX swap lines have a longer history; they were used to manage the gold standard at the time. But in the modern era, they became more actively used as a way to backstop the global dollar system. We have standing swap lines with our best friends, say Euroland, Japan, Canada. But in times of stress, we also open up swap lines to people who are still good friends but not as close, like Korea. This was something the Fed basically used for financial stability.

If Kevin Walsh is saying that this is an international finance thing and it's not something the Fed has full control over, that means the White House would be able to give Fed swap lines to whoever they think best in the nation's interests. Last year, we had the Treasury give swap lines to Argentina to bail them out, and that was very successful. That wasn't a Fed swap line; that was used using the Treasury's own cash from something called the Exchange Stabilization Fund. It's not very large; most of it is illiquid stuff like IMF reserves. It does have, I believe, 20 or 30 billion, but not a lot of cash. But if the Treasury were able to instead offer Fed swap lines, that's basically an infinite amount of cash. At the moment, rumors suggest that the UAE is actually asking for a Fed swap line. And Treasury Secretary Janet Yellen posting on X basically supporting the giving of swap lines to the UAE. Powell is not their guy, but if you have Kevin Walsh there and Secretary Yellen gives him a call, I see no reason why the Fed wouldn't be able to offer the UAE a swap line.

This is an interesting case because the UAE actually has a lot of dollars. Good work from Brad Setser shows that over the past many decades, the Gulf countries have accumulated a lot of dollars. Of course, at the moment they're not making as much money and they're spending more, but cumulatively over the past few decades, they've accumulated a few trillion dollars worth of assets. Some of that is in liquid stuff like treasury, some of it is in equities, some of it is in less liquid stuff like private equity. But they have a lot of dollars, and it's worth noting that they have their currencies pegged to the dollar. So, it's an interesting question why they would want a dollar swap line. Why can't they just liquidate their dollar reserves? They have so many. One reason to give them a dollar swap line could be just as an extra boost of confidence. I think that's the most benign reading. These guys have their currency pegged to the dollar. You don't want that peg to break. One way to have unlimited confidence in that peg is to say that the Fed is supporting them. That would tamp down on any fears of a breaking of the peg.

Secondly, one way they could support the peg themselves is if they have to liquidate their dollar assets. If they were to do that, that would have some impact on US asset prices. I don't think it would be huge, but you would probably see some upward pressure on Treasury yields, maybe downward pressure on stocks depending on what they sell. So it could be that the administration would like to avoid any disturbances to asset prices, and we know they are sensitive to that. So a dollar swap line could be helpful for that. But another reason this is super interesting is that a swap line is basically direct access to the money printer.

Let's say, hypothetically, that the US says, 'Hey, Mr. Arab Sheik, can you please support investments in the US?' It could be power plants, semiconductor companies, the new drone company by the Trumps, or the Trump coins. How are you going to finance that? 'Hey, why don't you just borrow from our dollar swap lines?' In a sense, it could be a way for the Treasury or the White House to conduct fiscal policy with unlimited money by laundering it through these third parties through swap lines. This is something they wouldn't be able to do with a country like the European Union or Japan, for example. These countries are democratic and transparent. So it's difficult to pull something like this off. But if you have counterparties like the Gulf countries where it's opaque, it's basically a dictatorship, and you're good friends with the ruler there, then this is something you could definitely pull off, and it would be something you could hide. The Fed, historically speaking, discloses their swap lines outstanding, but that's something they could change. Though it does potentially give the White House basically unlimited money through these third-party countries. I'm not saying this is how it's going to be used, but it's a possibility here. It really just depends on the institutional arrangement.

Oh, bonus segment: I have to show that Senator Warren asked Kevin Walsh her favorite question, her favorite test of Fed independence. Here it is.

Senator Warren: Start easy. Mr. Walsh, did Donald Trump lose the 2020 election?

Kevin Walsh: We try to keep politics, if I'm confirmed, out of the Federal...

Senator Warren: I'm just asking a factual question. I need to know. I need to measure your independence and your courage.

Kevin Walsh: Senator, I believe that this body certified that election many years ago.

Senator Warren: That's not the question I'm asking. I'm asking, did Donald Trump lose in 2020?

Kevin Walsh: I'm suggesting you... in 2020, the answer... your huge inflation problem and you certify the election.

Host: So she asks a lot of Trump nominees this question, and they all struggle. It's kind of funny. Kevin Walsh is like, 'Oh, 2020 election.' What'd you say?

Host: The last thing we want to talk about is the absolute boom in semiconductor stocks. This past week, actually the past few weeks, we've had new AI models released: new ChatGPT, new Claude, and even a new DeepSeek. All these models being released are showing good improvements in the AI models, and honestly, it seems to be more of a commoditized product now. But what it's also showing is that there is just an increase in insatiable demand for compute. So everyone wants more compute, more GPUs, and even more CPUs. That is leading to a frenzy where everyone is bidding up these semiconductor stocks. AMD going to the moon, Intel, as we mentioned earlier, just absolutely surging everything. So there seems to be this real rush, and that seems to be a big force that's driving the NASDAQ higher. When I look at this, it obviously looks like some kind of blow-off top, some kind of frenzy. Yes, the semiconductor stocks are going to make a lot of money. Whether or not that means their prices have to go to the moon, that's another discussion entirely.

The AI ecosystem now is looking super interesting in that all the big hyperscalers, the guys who buy compute, are actually financing that compute out of their tremendous profitable businesses and also by trying to save on employees. So you have Meta and Microsoft basically firing people and taking that money to buy more GPUs and trying to build out their AI compute structure. Even though AI is super great, it's not really clear whether these guys who buy the chips, who buy the compute, will actually be able to monetize their investments. I use AI a lot, but obviously I'm not paying that much money. I pay $100 for Claude. I don't pay anything for Gemini, and I use it. So I'm deriving benefits from that, and it's basically benefits that are subsidized by the huge cash flows of these companies. So it's not really clear if they will ever be able to recoup their investments. That's still good for the chip companies because they're still buying chips. But eventually, you could think of a scenario where these guys become more profit-minded, and so they actually have to charge for usage of the GPUs, at least at their costs. The question is, once they start charging for the use of compute, will there still be the same amount of demand for compute? Logically speaking, if they start charging more, or at least so that they don't make a loss on the compute, people are going to use it less, and that suggests less demand for GPUs and all that stuff. Not to mention, everyone is developing their own computes—Google and so forth. So eventually, you could have, at least for the pure chip companies, less demand for their products. So that's something to think about.

Also, I think it's really interesting that the Chinese model for AI is very different from the US. DeepSeek, even the newest one, is going to be open source. The models look like they're going to be commoditized, so it's going to be very difficult for anyone to make money off the model. So it's looking increasingly like that at the end of the day, because of competition, the model layer is just not going to make that much money. The apps, of course, are going to be fiercely competitive as well. Not sure they're going to make money. It's really the chip makers that are making tremendous amounts of money. So the market is correct in identifying that. Whether or not that persists, whether or not it justifies high prices, is another thing altogether. So very bubbly, very dot-com-like, and we'll see what plays out. Historically speaking, something like this always, always ends in some kind of implosion.

This week is a Fed meeting. The market isn't pricing any move. I expect it to be a very boring meeting. The only thing I'm looking out for is for Chair Powell to tell us more concretely whether or not he's going to stay at the Fed after his chairmanship ends. It's looking like he is going to do so, and there is some possibility that he just stays through, or maybe resigns later on in the year, say maybe when the Republicans lose the Senate (if they lose the Senate), and then that could just be an empty seat. Who knows? But it looks like President Trump to take over the Fed will be more difficult unless, of course, something changes and Chair Powell leaves in time for a Trump appointee to be confirmed. That's all prepared for today. Thanks so much for tuning in. I'll talk to you guys this week.