The Federal Open Market Committee meets Dec. 12 and 13, and will issue a statement and a Summary of Economic Projections. Rob Robis, chief global fixed income strategist at BCA Research parses the Federal Open Market Committee meeting statement, Chair Jerome Powell's press conference and the new SEP, and gives his view of what we can expect in monetary policy, including when he expects rate cuts.
Transcription:
Transcripts are generated using a combination of speech recognition software and human transcribers, and may contain errors. Please check the corresponding audio for the authoritative record.
Gary Siegel (00:09):
Hi, welcome to another Bond Buyer Leaders Forum Event. I'm your host Bond Buyer managing editor Gary Siegel. My guest is Rob Robis, chief Global Fixed Income strategist at BCA Research. Today we're going to discuss yesterday's Federal Open Market Committee meeting and all that went along with it. Rob, welcome and thank you for joining us.
Rob Robis (00:36):
Thank you for having me.
Gary Siegel (00:39):
So it was quite a day yesterday. Was there anything from the FOMC'S statement, the summary of economic projections or Fed Chair Jerome Powell's press conference that surprised you or grabbed your attention?
Rob Robis (00:56):
Yeah, I think the first thing that would grab my attention, this is more in the press conference, is that Powell's language on discussing the timing of potential rate cuts, the Fed discussion on when they had to start talking about rate cuts, this contrast that so much of what Powell just said like 12 days ago when he said it's too early to talk about rate cuts, it's preemptive to have that discussion. So something's happened in the interim and yes, we've had a good inflation report just the other day on the member CPI. Maybe that was enough to move the influence enough people in the FOMC or maybe once he actually got into the meeting with all the members that there was a lot more dovishness in the room perhaps he had thought even two weeks ago. So he has to, again at the press conferences, at the meetings, the fed chair often has to have his language reflect the views of the committee.
(01:49)
He can influence it a lot obviously as a chairman, but if there's a bias there saying Look, we have to start positioning for the rate cuts next year and start having a conversation with the markets, then he's going to have to say that in his language. So that means the first thing I struck is interesting is that it's the tone changing so quickly from a recent Powell comments and maybe the lack of concern or language around what the Fed calls financial conditions, right? The fact that stocks markets trading, well credit spreads are tight things that would normally be stimulating or stimulative for the economy and now a lot of that we've seen in the last couple months was also happening alongside lower treasury yield. So that was I'll bet on Fed easing that the market liked, the stock market liked. There's no pushback against that and Powell's oftentimes try to be the bad cop I guess there a little bit and say We don't like these markets being too bullish right now. We introduce some more risk in there and it could stimulate the economy more than we want right now. He didn't seem to have any trouble with that. He didn't even comment on it. He was asked that question, he kind of just glossed over it. So that was the other thing that stood to me really was that a real lack of concern is not a endorsement of what the markets have been doing the last two months, which is basically pricing in the soft landing Goldilocks trade of lower inflation but not significantly lower growth.
Gary Siegel (03:13):
It reminds me of former Dallas Fed President Richard Fisher who at the end of every one of his press conferences would say, I'll now avoid answering your questions.
Rob Robis (03:28):
Yeah, maybe an easier job with the Fed was only four press conferences a year, not 12, but you're right.
Gary Siegel (03:36):
So it sounds from your answer that you think maybe Powell doesn't agree with the committee and his statement yesterday was more of the feeling of the FOMC rather than himself. Is that correct? Is that what you think?
Rob Robis (03:54):
I wouldn't say he disagrees with the committee. The tone changed from so recently and something that could have been Powell likes to have a consistent message. So if the message as from the September meeting until yesterday was higher for longer, we can't declare victory on the inflation front yet on the inflation fight yet we're not seeing a loosening of labor market, those kind kind of language. Right. Maybe it's to maintain the language going into the fmc. So I dunno, I'm going to say it's a disagreement. It's just something has happened from very recent Fed speeches and maybe I think it's more of the FOMC in aggregate, maybe shifting more towards the idea that we have that inflation has now fallen enough that the Fed could feel comfortable about inflation hitting their 2% target and if you look at the pieces of CPI goods, goods prices are deflating in the CPI services.
(04:50)
Prices are coming down maybe not as rapidly as the Fed would like, but it's heading in the right direction. The job market's still fairly strong, but wage growth is starting to cool off and these are the kind of things the Fed want to see to be convinced that even the services side of inflation's coming down, so it did lower their inflation for the next couple of years. They're a little more reasonable now. In fact, just pull it up here as they read it to you, next year's inflation number from core PCE, you have 2.6 to 2.4 in 2025 and 2.3 to 2.2. These are I think a little more reasonable numbers. I mean it's small adjustments, but that's close enough to the fed's target within a two year window of when monetary policy impacts the economy to operates with a lag. So I think that maybe those numbers are enough in the new set of projections. Say okay, we can start saying and end of the rate hikes. Let's talk about the timing and magnitude of rate cuts as the next conversation with the markets and the public.
Gary Siegel (05:54):
Although of course Chair Powell would not commit to being done raising rates. He seemed to say that he doesn't think there's going to be another rate hike, but there's still that possibility. How much of a possibility do you think that inflation will for some reason that we don't know spike and it will change the Fed's plans.
Rob Robis (06:23):
I mean a second wave of inflation is something that it's not a zero risk because you still have pretty low unemployment rate. You still have an economy that is consumer spending still going on a decent clip may not be as robust as it was in the summer. Inflation that come down, gasoline prices come down. These are things that would keep the consumer spending story going as long as the job market doesn't fall apart. So I think the idea that they could have another wave of inflation if all of a sudden things get too stimulative, right? If the stock market rally in the soft reduced dollar and tighter credit spreads, lower mortgage rates, I they're still high. Obviously historical experience, mortgage rates will come down, get the housing market out of its frost thaw that has been conditional on the higher rates. Maybe that would be enough to get the economy reaccelerate and that could bring inflation pressures back because you still have wage growth depending on different measures.
(07:24)
You look at something more like a five to 600% growth rate and that's still too high to be consistent with the fed's inflation target. So yeah, this is a risk certainly or BCA, we discuss this a lot saying if the Fed decides to switch to a dovish stance or bias too soon before the economy really, really slows down, then you may see a risk of inflation picking up again and that would force the Fed's hand to say, look, we can't deliver the rate cuts that are currently discounted. So it is a fine line. They're treading between sounding appropriately, dovish saying because inflation has come down, but if they sound too dovish before inflation has fully gotten their target, good, can you see actual inflation come back yet because you end pushing that recession further out into the future, right. It's not a next year story, but yeah, the fed's tilt yesterday and Pivot I think does maybe raise the odds of other ways inflation happening, but there's enough momentum slowing I think in terms of consumer spending slowing enough that probably that's not going to happen end of a slowdown on natural recession. But yeah, it does raise the risk a little bit for sure.
Gary Siegel (08:37):
So the Fed expects three cuts next year. The markets are expecting more than that. What's your best base case for next year and rate cuts?
Rob Robis (08:49):
Yeah, probably somewhere between the Fed and market. I think as the market 150, a 60 basis points. I think at one point it was 1 75 from yesterday, how much is expected considering the Fed will want to see some consecutive months of weakness, not just the fact that inflation's slowing and they get forecasted because I think the Fed realizes their forecasts have been a little spotty the last couple of years. So I think in terms of getting inflation wrong, the upside and maybe not appreciating how fast it's going to the downside, sorry guys, I'm a drink of water.
(09:32)
So I think the idea of the Fed doing, if Fed want to see three consecutive months of rising unemployment and weak job numbers and inflation continuing on this path and not sort of stalling out in terms of inflation decline before they could feel comfortable, but delivering rates, so a rate cuts, so idea certain March that's currently priced in the market, which is how you would start to get to that market pricing of one 50 plus in terms of rate cuts, it is more likely maybe by second quarter, maybe by the June meetings more likely that to have enough body of data on that to say they can do rate cuts. But the change in tone yesterday does raise the idea, opens the door to March being a potential initial rate cut. I think it's more later, second quarter than early second quarter, but that's the case then how quickly they want to be cutting rates, if it's just rate cuts just to offset the fact that inflation's come down and not necessarily to stimulate a weak economy, that's a smaller number of cuts, right?
(10:37)
The Fed can deliver a hundred basis points of cuts, take the funds rate to four and a half and say, look, inflation's lower. That lowers the real rate. But we still want to, the economy is healthy enough that we don't need to be cutting rates and stimulating things and certainly a bullish equity market and those things, financial conditions that does some easing for the feds, they don't need to juice that with additional rate cuts. So I think I expect they'll start mid-year more than in the first quarter and go by less than the market, but probably 75 to a hundred basis points is good baseline with an outside chance they would go like one 50 depending on the economy, how much the economy weakens.
Gary Siegel (11:17):
So right in the middle?
Rob Robis (11:21):
Like I said, the conviction is they won't go by more than what's priced in the market. So in other words, the treasury rally has been, I think it's fully priced in that sense. I don't see a scenario where the Fed can do more than when the market is pricing.
Gary Siegel (11:35):
Well, here's a big question. November is elections, presidential elections, the Fed doesn't like to move too close to the elections. How will the politics play out this year for the Fed?
Rob Robis (11:51):
Yeah, it's interesting because if you just look at presuming it's going to be Trump versus Biden, president Trump has come out as recently, I think as August and said that he would not reappoint Powell if he was reelected. And I think the exact quote he said was he always thought Trump Powell moved to slowly both the good and the bad. In other words, he didn't tighten policy quickly enough and didn't cut rates quickly enough. I think and to remember during his first term, he did criticize the Fed for keeping the dollar were too strong saying that China keeping a currency weak was a competitive threat to us and Fed needs to cut rates so it's clear. So if the Fed is cutting rates to avoid doing something around the election as typically as the Fed does in election years, it may look like you're supporting the incumbent because the way election polls, election results seem to go, if the economy is strong, the incumbent has a good chance of winning.
(12:50)
So Biden's chance of reelection would be better if the US economy is better next year. And that's why it's interesting, even Biden who has said not said much about Powell and the Fed at all after the last payrolls report saying that we don't need additional rate cuts, a rate increases because the job market is stabilizing enough on its own. I'm paraphrasing what he said and then even after the inflation numbers this weak, some inflation's coming down, we don't need more tightening. So even the pressure from the White House on the Fed having to do more. So I dunno if that factored in at all, is Powell thinking about his future may like that job, maybe a situation where either way he'll be out of that job in a year's time or a lower year's time. But I think maybe the more important point the Fed wanting to not have to do anything around elections and then you do raise the perception that you're doing to favor one part or the other.
(13:49)
The famous one I guess was George HW Bush in '92 when he lost to Bill Clinton and he blamed Alan Greenspan on not cutting rates fast enough when the economy was in recession. I know is that's something that could happen again, we'll see, but I think that's something that it has to be part of the fed's thinking. And Powell said yesterday, no, no, no, we don't think about that. I don't buy that for a minute. I think that's they're easy in DC these political people as well as economists types, they know how it works and they are seeing the pressure from election year of a next president influencing the Fed. They don't want to be seen as biasing one party or the other. I think
Gary Siegel (14:33):
The vote yesterday was unanimous Rob, but the SEP showed a big divide going forward with monetary policy. In fact not next year but the year after is very widely spread. What are the implications for monetary policy based on having such varied opinions of what's going to happen in two years? Does it matter because it's so far out and they'll converge or is it an issue?
Rob Robis (15:06):
I think it just tells you, I think in terms of the forecast two years out, first of all I think it's hard for the Fed to make forecasts that far. I know they try to, but typically the dispersion of the interest rate dots does widen as you get further in the future. But I think it's also maybe a belief shifting belief in parts of the FOMC in terms of what they think a neutral interest rate is. And if you look at the median, the median dot on the median term, longer run fed funds rate still at two and a half, still belief that that's what the neutral level of the nominal funds rate 2% inflation target. That means the real interest rate is like 50 basis points. So still below maybe there's some on the Fed that disagree because then if you think you have to stimulate the economy, you need to bring rates below whatever you think neutral is, right? If neutral is two and a half three, you think that then it's cutting rates to there is not stimulating anything is bring rates to a level you think is consistent with stable inflation over time, but not something where you need that's designed to really juice the economy by bringing down borrowing costs. Maybe there's some of that and maybe there's even more disagreement in terms of the actual growth outcomes.
(16:25)
There's guys out there we don't know, I'll say the names are not tax of dots, but there's some FOMC members in the economy will be in better shape two years from now than, but it does I think raise the bar in terms of actually seeing the data move in terms of weakness for the Fed to cut more than discounted by the markets. Even the Fed itself says, look beyond next year, we don't know for certain. So I think that's why you raised a good point. The Fed shows the median dots in their table, but looking at the actual distribution, get a log of information there. But I think if there's that much disagreement where economies going to be two years from now, then maybe how the economy looks a year from now will really dictate where rates are going to be in 2025 and what the Fed can do beyond that.
(17:13)
Because that's in a way that's the most interesting part now it's not just debating cuts for next year. When does the fed stop? If it's a weak economy, then they're not going to just do the 1 75 discount. Do they have to keep on going? But if it's just economy's okay and inflation's a lot lower and they have to normalize rates just for inflation, then there may not be many cuts after that. So I think it makes monetary policy even more data dependent during the course of next year because there's a lot more disagreement in terms of even what the economy is going to do next year within the Fed and that's the only way you can get to those, that dispersion of rate outcomes.
Gary Siegel (17:51):
Well in fairness, it's been very difficult, even more difficult than normal to predict the economy in the future since Covid hit.
Rob Robis (18:00):
Yeah, I agree with that. It seems like a term I've heard used this year is of a ruling recession. That's not a recession nationally, but some parts of the economy did the worse than others. If you look at the manufacturing sector, it did contract this year. Look at the ISM numbers or the industrial production numbers. They did go zero or into territory consistent with a contracting activity, but service sector was fine for spending. People want vacations, the consumer is still there. So maybe now we're going to shift it towards manufacturing, be a little less bad inventory rebuilding, things like that. But then the consumer may have made a little more softer pace of growth given spending the last couple of years, a lot of covid stimulus money's gone in terms of things that really fueled spending this year. So it is harder to forecast the economy I think. It's not like the economy's one big behemoth right now. Housing's doing its own thing too is high rates. So I think you raised a good point there. I
Gary Siegel (19:02):
So do expect a recession. Do you think there's going to be a soft landing and if you see a recession, when does it start? How long does it last and how severe is it?
Rob Robis (19:13):
Yeah, I think the base case still has to be a mild recession second half of next year. And that is what the notion of what the Fed is in a lot of tightening. Even if you think that the level of neutral rates is higher than what the Fed thinks that it was always higher or something fundamentally has changed. More government spending now we've seen that inflation could go back to a high single digits. So it's not so hard it it's easy to get growth going in with nominal spending being strong. It's like we're operating the world of very low numbers, low inflation, weak growth. Oops, sorry I but in terms of things that kept the consumer going, I mentioned earlier the excess savings story. That's something we've talked about a lot at PCA where if you look, how much extra fuel for consumer spending was provided or resulted from covid, not just from people not being able to do services spending during Covid, you're at home, all we do is buy goods online, have it delivered to you and you couldn't go off and a big chunk of spending is restaurants and vacations and you couldn't do that.
(20:26)
So there were savings there. And then obviously stimulus checks, which were quite large by our estimates, the number was something around almost 2.5 trillion of excess savings by the end of 2021. And that's been coming down as people have been spending more than a greater share of their income for the last two years. And that's by our estimates, that pool of excess savings and you see it in the household bank deposits, you see other the data that's confirms this that's coming down that should run out sometime first half next year. And if already the Fed has done their own estimates on this, they think that the excess savings story is only still there. Access saving is still there only for the upper income quartile that for most people has run out and you're seeing now credit card usage go up, which at these high interest rates, that's surprising by those people are trying to maintain some level of spending and they don't have the big bank account anymore or cash and bank account to fuel that spending.
(21:26)
So that raises the odds next year that the consumer will finally crack and in the end you really can't have a recession with a consumer, it's slowing down a lot. You have the regional rolling recession, you can have a housing recession, manufacturing recession, but have a GDP that you actually need a consumer. So I think that's more of a second half of your story and it'd be a mild one for the reasons I just said that it's not going to be a sweeping across the board of GDP decline. It is something more concentrated on the consumer with other parts of the economy already having gone through that downturn, maybe actually rebounding. We'll see if this decline in treasury yields and mortgage rates is enough to get housing activity going in, I suspect it would be a 7% mortgage rate is still pretty high compared to down from eight. I think there's a lot of people who are waiting to buy as soon as they saw the hint of rates coming down. So if rates do come down more, I think you'll see the housing sector bounce back too.
Gary Siegel (22:27):
Experts have been expecting a recession for more than a year now and it hasn't happened. Will the delayed recession or if we don't get a recession, will that slow the rate of disinflation?
Rob Robis (22:43):
I think you can get what's what we'll call a growth recession, which is growth being very low below what would be like a long-term trend growth rate could probably two point a half percent over time. So I think south of that would probably loosen up inflation pressures. You see a little bit of rise of unemployment, you see wage growth coming down. Companies get away at paying workers less, a little less demand. Maybe consumers are a bit more choosy on price, which if you kind of hear what the retailers are saying and their earnings reports and their earnings outlook, they do some talk about that saying that the consumers are fighting for better deals, holding off on better deals, which is something we hadn't seen the last couple of years I think.
(23:28)
So I guess the ability, it's I, it's the consumer story and if inflation does come down enough that could also the consumer going a little bit too, a little stronger here too. But in the end, any kind of recession call for next year recession outlook, it comes down to the consumer again, I think in the jobs market and that's what the fed's watching the jobs market people have jobs they'll still spend. They may be a little hoosier on where they spend, but if people are worried about losing their jobs or the job market's a little more friction in the job market, say it's just harder to get a job or fewer job openings. We've been seeing job openings, numbers come down, that may be enough to work consumer confidence a little bit and then we'll see if companies start laying off yet. Whereas right now companies don't have to do whole scale layoffs right now. I think it's something in terms of keeping the consumer going to have to see something in terms of businesses start to be more under blood pressure to lay off. That's why I think it's more of a second half next year story, not first half next year's story. In terms of that weakness showing up in the data,
Gary Siegel (24:40):
Well consumer confidence had been dropping and then the conference board reported last month that it increased a little. Do you think that's just the holiday spending or do you think consumers are seeing something in the economy and seeing that there are jobs available still even though there are fewer jobs and that people are working? What's your take on that?
Rob Robis (25:06):
I think there's some of that. There was the job market being resilient, but I think if you look at probably the best correlation last couple of years, there's consumer confidence and gas prices or energy and those keep coming down. So maybe it's just the lower inflation, the prices may still seem high in a lot of items for a lot of Americans, but in terms of the rate of change, gas prices being one that's most visible, they'll come down and that may be enough to think, okay, wages are growing depending four or five, 6% for an average American and inflation's now down 3% on its way down even lower. So all of a sudden your real wages go up, your real spending power goes up. So maybe some catch up there in terms say, okay, now I feel a little more comfortable. I'm not saying it doesn't cost me the same an increasing amount of fill my gas tank every week, it was last year or year before that.
(25:55)
So I think that's probably the reason. I think the absolute level of consumer confidence is still relatively low. It's off the lows from last year, but it's still below the peaks we saw before covid. So I think it makes more sense is that recovery being driven by the low inflation than sort of been proven on the economic outlook. Although you're seeing the consumer expectations part of those surveys has also ticked up, but I get a feeling that's correlated to what's happening with the lower inflation as well. It seems like even as the economy has been relatively strong the last couple of years, if you look at the survey polls, public opinion polls in the state of the economy, people think it's good or bad, they think it's weak and then they talk about inflation as being the reason. So it's not that GDP or job unemployment, just that high prices, something is wrong in the economy because my spending power has gone down. So maybe it's just unwind of that is enough to say improving spending power, I feel better about the save the economy. That's what I think is going on there.
Gary Siegel (26:58):
Well, the average consumer does gauge the economy at the gas pump and the cash register in the grocery store.
Rob Robis (27:06):
Absolutely.
Gary Siegel (27:09):
Do you think the full impact of past rate hikes have worked through the economy yet or is it still some impact to come Rob?
Rob Robis (27:18):
I think there's still some impact to come. The reason I say that is that from the point of view of household balance sheets and company corporate balance sheets, there was a lot of de-leveraging that happened. If you look from all the way in 2008 to the start of Covid household debt as a shared gdp, DP in US fell and a big chunk of that was the mortgage side and obviously there's no subprime borrowers anymore. It's harder to get a mortgage for a lot of Americans or at least the standards went up. So some of that, but even credit card debt that happened went down, households were recession was so severe. Those kind of shocks like 2008 can have a lingering impact in terms of how people think about spending going forward. So what it means is that when you do have higher rates, you have a less interest rate sensitive balance sheet in terms of your exposure to higher rates.
(28:13)
Same with the mortgages. People locking into their low mortgages two, three years ago. We got to know that story now and that's one of the reasons the housing market has housing activity has been so low, just people don't want to sell a house. Then we have a two 3% mortgage right now. They get a new house, seven 8% mortgage rate. So it makes the interest rate sensitivity of the economy through that very, very interest rate sensitive channel, which is housing. And so me that's reduced the rate sensitivity. It means that the cycle has to be drawn out longer. Eventually people will take on mortgages at higher levels whether they were waiting for, they need to move for whatever reason, for personal reasons, or they're just hoping to see a little lower rates before they can come in buy again, you may start to see the average household kind of debt interest rate pick up it more, but I think that's one of the reasons why you've not seen the consumer be impacted by higher rates as much because a lot of their spending and their balance sheet is a little more insulated towards higher rates.
(29:21)
Same thing with companies, right? In 2020 when the Fed did their EA and response to Covid and the covid shock, they also put a program in place to kind of support the investment grade corporate bond market. Remember the Fed actually had up a program saying it promised to more or less roll over the entire stock of investment grade debt. Have you rolled over for one year? We didn't have to buy that much because that promise was enough for the investors to come in and buy that. But a lot of companies were termed out their debt at low rates and in some cases very historically low rates. In some cases it means you don't until you have to roll that debt over, refund yourself, your company that your interest sensitivity has gone down as well. So next year you do start to see the corporate, they call it the corporate debt wall maturities that have to be refinanced and start to pick up next year investment grade and next beyond that 2, 3, 4 years, it really picks up.
(30:14)
So a lot of that borrowing that was done by companies last couple of years will be refinanced. But that's not a huge problem even for next year I think. And I think it still tells you that even corporate America is less rate sensitive. Small businesses, maybe they don't have access to corporate bonds, they're more reliant on banks. Banks have been tightening lending standards. A lot of regional banks after the SVP Silicon Valley bank crisis in the spring that may be less willing to make loans. You do see that the small business surveys do reflect that they're saying a little harder to get money than in the past. So for the most part, I think the interest rate sensitivity of the economy is just a lot less because of how businesses and households adjusted their balance sheets over the last few years. It just means the rate cycle may be more drawn out than usual. I mean sometimes it takes up to two years for rate cuts start to impact the economy. There's been cycles like that. This may be one of, could be even longer, we'll see. But by next year you're getting a point when you're two years from the start of the tightening cycle, it should start to impact more, I think a greater conviction that the high rates are going to impact in the economy next year than this year even allowing for a longer lag.
Gary Siegel (31:30):
So Jay Powell said at the press conference yesterday that the Fed isn't going to wait until inflation is down to 2% to cut rates because if they wait until it's down to 2%, it's too late. What's the possibility — you mentioned earlier that some people think that Jay Powell has waited too long to raise rates and now is waiting too long to cut rates — what's the possibility that they'll be late on making that first cut?
Rob Robis (32:02):
Yeah, I think because of the Fed taking criticism for not tightening policy as quickly as they should have, as inflation went up, they've been slower on the way down to maintain their credibility. That's why yesterday's language that needed, it's a shift in tone, but they still kept rates on hold. They're not saying they're going to cut rates in January. They're saying the discussion's happening and maybe the market's got ahead of itself, but I think the F can forecast the forecasts have inflation going down closely to target, but if they're forecasted re believed, they're not getting back to 2% next year I say it was 2.4% next year it's maybe close enough, close enough for government work as they say. But it doesn't actually happen that pace or if the Fed actually was to take that risk and say, okay, we think that inflation's going to end up there.
(33:00)
So to Powell's point, we have to start moving now ahead of that move because inflation's a lagging variable. It lags the economy and we're now worried more about the economy, the implication of it, right? They cut before inflation got all the way to two and the actual data, that means they are thinking that the economy needs a little kick. And also the fact that I said as inflation comes down, real rates are going up, that means the policy gets tighter in that perspective, they have to do something to offset that. So I think I would've thought the Fed would be late again next year. That was my belief before yesterday. Now I feel introduces some new risk in there. Are they willing to take some inflation risk, say cutting before you clearly have inflation at the 2% target and you clearly see a lot more weakness in the jobs market, will they be willing to do that on a forecast? The economy's going to be requiring easier policies the next couple of years. So you have to do something to begin that process now. So I think it's a greater risk now that the Fed left will this time be a little more preemptive or proactive than what has been the case of last year where it looks like inflation was coming down and they said, fine, we want to see this happening. So we're not going to talk about rate cuts anytime soon.
Gary Siegel (34:19):
The Fed uses backward looking data to gauge the economy. What's the impact of that? How much of a difference does that make? Is there anything they could use that would give them a better idea of what's actually happening in the economy rather than a month ago or three months ago?
Rob Robis (34:36):
Yeah, I mean in the end they call it data dependency. All central banks have to operate in this environment where you can have models and forecasts that look at past cycles and say, okay, this based on these changes and unemployment and oil prices, et cetera, we should think what inflation will be at this level, right? Two years from now. But that's still forecast as a model. And the Fed has even admitted their inflation models not worked last couple of years and Powell did talk a little bit about yesterday, even more supply is a bigger reason, bigger driver of inflation, not just demand. I mean it's as if the fed stimulating policy creating excess demand that caused inflation. It's more like supply came down, supply restrictions because of covid, everything else. So that's more what's driving inflation. So I do think because of that, because a kind of inflation that we haven't seen in quite some time or at least doesn't fit in the fed's models, that they do have to see it more in the data.
(35:40)
I think that's why they're relying so much on backward looking data. But there's no way you can operate monetary policy without a lag. You need to see the data first to justify to calibrate where your policy's going to be. So this is not just defense problem, this is ECB Bank of Japan, unanimous any central bank. They need to see what's in the data, validating what they're forecasting, what their models tell them and what they think is going to happen. So now fortunately, inflation itself is the most lagging variable, right? If think it's growth, eventually up growth create more jobs and that creates moves unemployment and that starts to then push up inflation as the economy operates at tighter capacity levels, by the time you see the inflation picking up the economy, it's already very, very, if they already operate with raising rates only when the sea inflation went higher, they're going to be late. But they also, they start cutting rates. Only the see inflation going lower, they're going to be late. But I think in this case, because there's no way get around looking at lagging data, I dunno how else they could do that. Especially because even more so now because they feel less comfortable with their forecast and their models even what's happened the last couple of years.
Gary Siegel (37:00):
So Rob, given the SEP yesterday and the Fed's projections for three cuts, how close are the market expectations and the Fed's, they're closer than they were a month and three months ago, but do you consider this close or do you still see them as far apart?
Rob Robis (37:23):
I mean prior to the meeting where the market's pricing rates for next year, that will still below the lowest forecast from the September Fed dots fed projections. Obviously that bill number came down so that got the fed closer to the market, but then the market added. We now a little lower yesterday too. So there's a convergence now I think that's interesting to me. The Fed is the market leading the Fed, maybe more case of the market is telling the Fed something. If the market's willing up to price in this much easing, then the Fed has to consider there's something going on then in the economy inflation to justify this, right? So they could have pushed back against it yesterday, but that may be increasingly difficult to do. An example of that we just saw this morning with the European sector bank where their inflation's falling as fast and even faster than the U.S. The economies inworse shape than the U.S. but the ECD voted to keep rates steady and said higher for longer is still what they're looking at.
(38:34)
And there bond market, you look at some of where interest rates are in say Germany we having today, you saw bond yields fell in response to what happened in the US overnight for them and then yields drifted a little higher as e ccp hedge lag regard was the president of lag guard was saying what the keep rates higher for longer and rate cuts to too soon for that. But the market didn't really push up rates that much. There's a credibility issue saying, look, your inflation numbers are falling fast, your economy's flirting, recession in big places like Germany. Whatcha are talking about raising rates? Let's talk about rate cuts, right? So I think there's a credibility issue there where now credibility the other way where it's like, okay, you did your tightening, congratulations, inflation's come down, but you can't be overstaying the hawkishness for too long.
(39:19)
That's a risk to downside. Even Powell did mention that yesterday saying the Fed recognizes the risks of being too tight for too long at this particular moment, which is not something that he's been decided been saying much of recently. So I think that's something that the Fed has to factor in right now is the fact that they can't overstay their welcome of being too tight for too long because that just increases the potential for greater economic downturn and need a bigger inflation overshoot. The downside that they don't want, that there's inflation, they want to keep a nice steady path inflation now 2% without the economy blowing up. That's the soft landing scenario, right? Right now I think that's still possible if they make sure the economy doesn't tip into recession because policy's too tight for too long.
Gary Siegel (40:07):
Rob, what do you see as the biggest risks to the economy and the economic outlook going forward?
Rob Robis (40:15):
Well, I think the belief now that recession is avoided, this was this discussion all year. You mentioned earlier, even though there's people sitting around tables and meetings and if you're interviews in this forum, we're talking about inflation recession risks this year, but you just didn't see it, right? The labor market didn't loosen up that much, didn't see layoffs pick up. So now that the Fed is saying, okay, they'll say the recession's going to be voided and we start talking about unwinding someone's policy thing next year that just get the economy into another gear and get exuberant again. And then another wave of inflation higher as I mentioned earlier, and then the fed can't live around the rate cuts or just the risk is that I said earlier, the monetary policy lags hit next year. So just as we think the economies in soft landing actually is about to go in recession, those are different risks, but they're both plausible.
(41:22)
But I think the starting point is still by any measure we look at monetary policy is too tight in us, so it's going to impact the economy next year. So maybe some of these soft landing scenarios and really juice the equity market in the treasury market may be a little too optimistic and then it could be, I think that's the way we've described in our internal meetings that the moment the recession, most likely timing or recession will be when no one thinks it's going to happen the opposite of this year, wherever I thought's going to happen. But then people prepared for it, but the underlying conditions weren't there yet. I think most CEOs in America are reading the Wall Street Journal this year, all recession risks picking up and they probably had a plan on their desks of who they're going to lay off them things for themselves and didn't see it. Right. Maybe there's a greater chance of that next year because now the optimism is now swung in the other direction or is a lot in that direction. Where's more optimism? Sorry, we supposed to talk, sorry. You mentioned politics earlier. I don't know if a change in government could be a big shock. We do a geopolitical tensions around the world. There's a lot of noise going on right now, but I think in terms of the economy, it would be the monetary policy lags hit next year just as when people think that recession risk was done.
Gary Siegel (42:45):
So what does all of this mean for the bond market?
Rob Robis (42:47):
I mean definitely we're done with the tightening cycle. We had thought that even as of last August, September, there's a we'll final first higher and 10 year yields get shipped to 5%. That was because the economy looked a little better expected at the end of the summer. But now if the Fed is not going to be threatening to raise rates anymore and inflation has come down a lot, it's pretty hard to see why bond yields and rates have to keep rising. So I think we've seen the peak in rates at the funds rates. Only five and a half will be the peak I'm discussing now to the level of cuts next year. Bond yields have fallen a lot. It's amazing to me that you can have these a hundred basis point swings up and down treasury market in a span a few months. That's pretty unprecedented or pretty wild volatility certainly compared to the last, what we're used to bonds the last 20 years or so prior to covid.
(43:47)
But I think I said a lot of the treasury yield decline now is discounted a pretty realistic scenario for the Fed next year. So to get lower yields from here sustainably below four, you got to be talking about the recession odds picking up, right? So I think me, I would say that it's been a great rally in treasury from five down to four. I want to say that's the easy money being made, but that's the most straightforward part is that you've gone from pricing and the risk of the fed higher for longer to now debating when the cuts will have and Fred's gone swung too far the other way you might see yield stabilize here and the next leg down being driven by more signs of decisively weaker growth next year. But I think the peak is in for treasury deals and the Fed. So I think that's the treasury market.
(44:36)
It's already been a pretty bullish move the last couple months, but I think it's means that the bond bear market, we've seen Danny Mac is sort of the lows in 2020 to the peak in the about two months ago that's done. So I think there's a lot of money that's still investor money that is still parked in cash. They'll look to say T-bills at 5% ish is a good trade until you can sort out what the economy and what the fed is going to do. Monies has come back in. You see a lot of buying and the TLTF and retail investors are buying treasuries. They participated in that. They moved down in yields. There's still going to be more cash to work someone's going to on the stock market, yields go down. But I think some could go on in the treasury market.
(45:19)
So I think most likely scenario, I think it was a year from now, we're going to see lower treasury yields, perhaps three and a half, three and a quarter would be, I think were a likely target and it could be more if the Fed has been more aggressive. But just in terms of slower growth, slower inflation pricing out more of the rate hikes we've seen in the last couple of years. There's some bumps along the way because I think the market's a little too aggressive in the near term terms of pricing, but you could see yields that's where yields will bottom up if not, and next year, sometime maybe even in 2025, I think it's a downward path for yields from here. So the bond bear market is over. So
Gary Siegel (46:05):
What questions are you getting from clients? What are they worried about?
Rob Robis (46:13):
I told you yesterday I would've said they're worried about the fed being too hawkish for too long. So I don't know if that changes things. I guess the inflation story, some clients do ask questions like could inflation read down and have we seen enough to decline? Some of these is some belief that we haven't slayed the inflation beast just yet when it comes to things, bond strategists also talk about things like corporate credit and things like that, and a lot of clients still seem pretty comfortable owning corporate debt. The yields are high, but then when I tell them, but spreads are tight, so it's kind priced for perfection that way. Look where credit spreads are versus treasury yields. And those kind of, when I raise that point, I get a lot of nods and yeah, we know, we know, but these yields are so high I got to buy them and there's no recession. Then how back can the credit market get? So I think maybe there's some of that's not necessarily a question I'm getting, but a bias. I infer when I talk to these clients and say there's an inherent bullishness and maybe the idea that this is opportunity that these yields are once in a lifetime I got to buy 'em. But if it's treasuries that make sense to me in credit, there's going to be more risks that the economy itself and credit quality goes.
(47:32)
And a lot of questions on the election next year wasn't even with the Fed. We talked about that already and it's all speculation at this point, but that's on everyone's radar for next year I think, too.
Gary Siegel (47:43):
Very good. We're out of time. I'd like to thank my guest, Rob Robis, chief Global fixed income strategist at BCA research and I'd like to thank all of our audience for joining us today. Have a good afternoon everyone.
