Yahoo Finance’s Julie Hyman, Myles Udland and Brian Sozzi speak with Wells Fargo macro strategist Mike Shumacher about the Fed’s move and the economic outlook.
MYLES UDLAND: Mike Shumacher joins us now, Senior Macro Strategist at Wells Fargo. And Mike, you got your grade right at the top. Two points equals double trouble for the Fed. How did you kind of read this plot when it came out? And how did you think about the implications, I think, of a bigger than expected change in that FOMC forecast?
MIKE SHUMACHER: Yeah, that was surprising, Myles. There aren’t many questions on this. I think a lot of people in the markets thought the Fed would stand firm or maybe tackle just one rate hike. But two, I think, caught most people off guard.
And from our perspective, there were a number of interesting take out options. I would say first and foremost that the Fed has significantly revised upwards its inflation expectations for 2021. So that tells us that the Fed is still guessing, like all of us, for how long this surge in inflation will last.
But the other thing that interests us is that if you take the years 2022 and 23, there was very little change in the Fed’s inflation projection. So it’s quite interesting to see the number of rate hikes drop from zero to two, when the inflation forecast is mostly static. It’s kind of a disconnect that’s hard to get around.
And the press conference, frankly, didn’t learn much from that. I think President Powell is trying to maintain maximum flexibility. Much speculation is when the tapering talks really pick up, when tapering certainly begins. But for us, it was really two rate hikes, and also the change in inflation.
JULIE HYMAN: So Mike, what explains the disconnect between changing rate expectations and the fact that inflation projections don’t change? Is this somehow a nod to the market? Is it some sort of tacit acknowledgment that maybe it’s not transient, or maybe it’s going to be more persistent? Or the transient nature may last a little longer, but still be transient? What do you think?
MIKE SHUMACHER: Yeah, that’s interesting, Julie. I suspect the most important thing to focus on here in terms of why you have this lag is that this is really a committee. And when you consider the points in 2023, they are everywhere. So that tells us that there is a very wide range of points of view.
And that also tells us, I think, that the level of confidence in the inflation forecast is quite low. Perhaps that indicates that a number of people in the FOMC are saying, well look, inflation has gone up a lot more than we expected over the past few months. Maybe it’s going on longer than expected. Therefore, it seems pretty sane to say why don’t we have one or two rate hikes over 18 or 24 months.
So I really think it’s this very diverse committee. Many different views on the image of inflation manifested in rate hikes.
BRIAN SOZZI: Mike, what happens to the bond market after what we heard from the Fed yesterday?
MIKE SHUMACHER: Yes, the bond market has really had a pretty big wake-up call. And when you think of other central banks, there’s been a lot of talk about not tightening, but at least becoming less accommodating.
But for the Fed, going down this path is a challenge. And many of the investors we spoke to believed or thought rates would stay pretty low for a long time. Maybe the yields would increase over the next six months, but quite gradually.
They were therefore quite comfortable implementing strategies to try to obtain a little more return, a little more return, the so-called carry strategies. It becomes much less comfortable today after hearing from the Fed.
MYLES UDLAND: Yes Mike, another thing we talked about earlier in the program was, you know, what would be the conditions in 2023 that would justify the Fed rate hike. I’m curious, based on the economic projections that have been offered, it looks like the Fed thinks there is a scenario where it’s a 2015, right? Where you have an economy that is performing as well as the Fed would like, and they want to normalize rates. But there could also be a scenario where it’s inflation that encourages the Fed to raise interest rates. How do you ask yourself what would actually trigger the Fed to make these two rate hikes, which now appear to be on the table in a few years?
MIKE SHUMACHER: Yeah, Myles, it’s probably a balancing act. And as President Powell keeps pointing out, yes, jobs are half of our term. So we’ll focus on that. We will focus on inflation. It’s really a function of how the Fed weighs these things, call it 12 months.
And at this point, the Fed isn’t really telling us how that scale works. So if unemployment continues to fall – and it has dropped dramatically over the past six months – that’s a big bright spot. But if inflation remains high, the Fed needs to think about it. I guess in the ideal world the Fed would like to see unemployment drop to 4%, maybe a little lower. But the inflation picture may not give him that opportunity. And that’s why we’re still bearish, frankly, at Wells Fargo.
JULIE HYMAN: Mike, something that always amuses me about this whole exercise is that they don’t know what’s going to happen in 2023. Nobody knows what is going to happen in 2023.
For example, you might have some visibility over the next 12 months, but given, for example, what the jobs report has shown over the past two months, I would dispute that we even have visibility for the next 12 months.
So you know, I don’t know. I don’t know how my question relates to all of this. I guess I’ll come back to you guys being bearish and why you are bearish, and what kind of screw – what do you know? What do you feel like you know for sure right now?
MIKE SHUMACHER: I’m thinking of a couple of things there, Julie. First of all, to your semi-question, the economic data which is super difficult for everyone to predict. And that tells me there is so much uncertainty out there. I mean, listen, we have a once-in-a-century pandemic. So nobody has put that into some kind of econometric model. You do not know. And that means we all need a dose of humility.
So in terms of what we’re pretty comfortable with, say, 12 months, or maybe longer, we think inflation is going to go up like it has been, go down, but probably stay even longer. higher than it had been in 2017, 2018, that period.
And also, when you think about this huge amount of stimulus that’s in the economies of the world, it has a huge impact in really trying to kick start this recovery pretty quickly. So you’re going to see growth figures that go off the beaten track for many countries. And that, we think, puts a lot of foam on the markets, the labor markets in particular.
So what we know later is that central bankers feel less comfortable with this sort of thing. Maybe they don’t come back to anything we saw in 2017 or 2018. But it seems to us that tackling a few rate hikes here and there, whether from the Fed or ‘other central banks, is quite cautious. And we think it’s quite likely.
So at 12, 18, 24 months, those predictions become much more comfortable. From month to month, really nobody knows. You can’t tell what the next payroll report will be plus or minus a few hundred thousand or the next impression of inflation plus or minus a few tenths.
MYLES UDLAND: And Mike, quickly before you let go, Jackson Hole tends to be a highlight for Fed watchers. Do you feel like this is gearing up for another event where we could get that signal on the reduction, as was almost suggested yesterday?
MIKE SHUMACHER: It’s possible, Myles. It seems a bit too early to us.
And the reason I say this is that there is still a lot to learn in the job market. I just said it would get stronger. I’ll stick to that. But I think we’ll get a better idea of how it works when all of those extra unemployment benefits are gone, and also when the kids go back to school. So, I guess it’s the September period. So we get these data points in October.
So Jackson Hole, maybe. Yes, a big scene, a lot of attention. But it looks like it’s probably a few months earlier for us.
MYLES UDLAND: All right, Mike Shumacher, senior macro strategist at Wells Fargo. Mike, appreciate the time. I know we’ll be in touch.