Roundtable: What to Expect from Today's Fed Meeting

Assessing the Fed's strategy to curb inflation is at the forefront of investor's minds

Jul 26, 2022 at 11:19 AM
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    It's a monumental week for investors or anyone adjacent to the stock market. The Fed meeting, the GDP report, and all of the recent inflation data are converging on markets. To help grapple with it all, we posed some questions to several industry experts:

    The recent unemployment report, the latest earnings reports, and the CPI are all somewhat at odds about the direction of the economy. With these three factors all unfolding recently, will any of them change the Fed's direction? Which matters most?  

    What are some possible outcomes of the FOMC meeting this week?

    Van Hesser, Chief Strategist at KBRA

    The Fed has shifted from being pragmatic about monetary policy to ideological, as in inflation must be brought down, so inflation measures matter most.  As for unemployment and relatively strong earnings reports, those are backward-looking.  At last year-end, we hit an inflection point in the economy, shifting from extraordinary, stimulus-fueled growth back to a more familiar, low growth paradigm.  The speed of that correction and the direction of travel has unnerved markets. 

    We expect a 75 basis-point hike.  A 50 basis-point move would send the wrong signal that the Fed pivot is underway before the task at hand, bringing down inflation, has been completed.  Alternatively, 100 basis-point runs the risk of spooking the market.  

    Jeanette Garretty, Managing Director & Chief Economist at Robertson Stephens

    “At this moment, there is only one thing that matters to the Federal Reserve: inflation.  And Chairman Powell made quite a statement after the last FOMC meeting that “headline inflation”— the CPI— is the number he wants to see go down, convincingly, and consistently. As such, there is little that will change the Fed’s view before the FOMC meeting next week.“

    Crit Thomas, Global Market Strategist at Touchstone Investments

    “Inflation is the key. Economic growth was expected to naturally slow this year after record growth last year. Also, fiscal stimulus has run out. So, signs of slowing growth should come through, but the picture remains mixed due to the unique backdrop created by the pandemic. Spending in some areas are slowing, while other areas are picking up due to pent-up demand. Throw in a war and continued supply disruptions and it makes data interpretation difficult.

    Now let’s turn to the Fed. Clearly inflation has been coming in way higher than they expected and they are late to start tamping it down. The Fed has a blunt instrument, and it works best at correcting demand side inflation. But there are plenty of supply side drivers to inflation, that suggests that we will also see mixed inflation data and that it is going to take additional time to address supply side inflation. It does help that most central banks around the world are raising rates as well.

    So, what does the Fed do from here? If there is one person vilified at the Fed, it is Arthur Burns. Arthur Burns made two mistakes. First, he let inflation run up as he felt the drivers behind inflation were out of the Feds control. Which sounds a lot like transitory inflation. Burns is the one that started excluding Food and Energy from inflation reports. He was also dealing with a unique labor situation. Powerful unions were pushing through wage increases – another thing Burns didn’t think the Fed could influence. On the other hand, the unemployment rate was running high as baby boomers flooded the labor force (Powell doesn’t face this backdrop). That led to his second mistake, and that was backing off from tightening too soon as economic conditions weakened and labor conditions worsened. As such he wasn’t able to halt the inflationary forces and inflation came back and make new highs. Admittedly he was in a tough spot.

    Now look at things through Powell’s eyes. He is already halfway to being associated with Burns by waiting too long to address inflation. Powell will forever regret his transitory message. Now put yourself in Powell’s shoes. Do you err on the side of tightening too much or too little? If he chooses too little, then it is likely his name goes down in history right along with Burns. If he chooses too much, then we go into a recession for which he will get blamed. But Volcker put us in back-to-back recessions and is now thought to be the best Fed Chair in history.  So, I think the Fed will continue to tighten in the face of weakening economic conditions….

    As long as inflation remains stubbornly high. Which gets us back to my first comment – inflation is the key. One thing I heard Powell say recently was that he has learned that we really don’t understand inflation that well. It’s true, so it is with much humility that I put forth my base case. I believe that inflation comes down slowly for 2 reasons. First is due to all the supply side drivers for which the Fed’s tools are less effective. Secondly is that the Fed really hasn’t even shifted to a tightening stance – real rates are still very negative. If true, then the Fed is likely to keep putting downward pressure on the economy and may not let up as soon as many expect. Admittedly I could be wrong – the message the markets seem to be sending is that inflation falls more rapidly and that the Fed is able to start easing as soon as 1H23. We shall see.”

    Michael Gajewski, CFEd

    I was just on a virtual session with the CIO of PIMCO and Dr. Ben Bernanke earlier today talking about the very talking points you mentioned in your query.

    First off, some basic economics - Leading, lagging and coincidental indicators are all important aspects of gauging economic states. They're all pretty important with regards to analyzing economic status. Leading indicators, like the CPI, give us some insight into what’s possible in the future. Profit reports are lagging indicators meaning the only way to know that information is for the event to already happen. These indicators confirm patterns or trends we are trying to pay attention to. Economists and analysts rely on all sorts of indicators to have more accurate data and potential projections. Many of these reports contradict the "recessionary" talks we are hearing. For unemployment to be at apx 3.5, wage growth and consumption rates - this definitely doesn't feel recessionary. However, recent interest rate hikes have people worried the fulcrum will start tilting. I believe the Fed sees that the troubles with supply chain caused by covid shutdowns mixed with increased consumer demands have created an inflationary storm. People are chasing goods that just aren't readily there. The way the Fed can curb this inflationary monster is through OMO tools like increasing interest rates. I think the hope is if the fulcrum tilts too much, the indicators reveal a potential soft landing or small short term recessionary period if we even get there. My hope is rising rates will curb inflation without pushing us into a recessionary period whilst not impacting consumers and buyers too much.

    Peter Jones, CFA, senior vice president of research and portfolio management with Ferguson Wellman Capital Management.

    The recent unemployment report showed a) strong job growth b) strong demand for new hires and c) unemployment rate at a very low 3.6%. In a vacuum, the labor market is incredibly healthy, consistent with a strong expansion.

    Earnings season is about 20% complete, with nearly half of those reporting coming from the financial sector. Thus far, aggregate earnings growth is at 6.3% compared to the year ago period, meaningfully stronger than the 1.2% that was expected out of the companies that have reported. ~6% earnings growth is consistent with a solid economic backdrop. However, fossil fuel companies are driving a large part of this growth. Energy companies are expected to grow earnings by around 200% this quarter. For the banks, earnings are down 20% but this is a function of comparing this quarter the 2Q21 when profits boomed because banks released contingencies for bad loans as the economy was coming out of the pandemic recession. In other words, bank operations were strong this quarter and the decline is more of an accounting irregularity than it is an indicator of shrinking profits. Most importantly, all of the banks were in unison in their declaration that the consumer is in strong shape.

    Last week’s CPI report showed 9.1% inflation, the highest in 41 years. High levels of inflation are consistent with a strong economy, but typically foreshadow economic slowing or even a recession as central banks need to raise rates in order to contain price inflation. The only encouraging aspect of the inflation data last week was that “core” inflation e.g.., inflation ex-fuel and ex-food has moderated from 6.5% a couple of months ago down to 5.9% in last week’s data. While the absolute level is still much too high, the trend-change is encouraging.

    In terms of the Fed …

    • Continued strength in the labor market gives them the green light to continue hiking. Monetary tightening and falling asset prices are yet to impact the labor market
    • ~6% earnings growth is another signal that the Fed can continue hiking. If earnings growth was already declining, the Fed could potentially worry that if they tightened much further it would exacerbate pressure on corporations … but that is not currently the case
    • 9.1% inflation likely intensifies the Fed’s conviction that they need to continue raising rates.
    • Out of the three factors, inflation is by far the most important in determining the path of Fed policy. The Fed will continue hiking at a rapid pace until there are signs that inflation on both a “headline” and “core” basis have begun to moderate.


     

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