Power Lunch - Fed Holds Steady 3/20/24

Episode Date: March 20, 2024

Stocks are on the rise, with the S&P 500 topping the 5,200 level for the first time as the Fed held rates at a 23-year high and maintained expectations for 3 cuts before the end of 2024. We’ll break down what that means for markets and your money, right up until Fed Chair Powell’s press conference. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to Power Launch, everybody. Alongside Courtney Reagan, I'm Tyler Matheson. Glad you could join us today on this busy Fed day. We're just four minutes from the Fed's latest decision on interest rates with no change, Court, expected for now. That's true, but let's get a check on the markets and where we stand ahead of the actual decision. Fairly flat across the board. Dow Jones Industrial Average, just marginally positive S&P 500 and the NASDAQ composite are lower by just a touch. Industrials and materials leading the way for the sectors, real estate, and health care. the laggards. All right. Let's get right to our all-star panel as we are just minutes away now from the Fed decision. Joining us, as he often does, David Kelly of J.P. Morgan Asset Management, Kristen Bitterly, of City Wealth and John Bellows of Western asset. Meantime, let's get, are we going to go to Steve here? No, we're going to wait and go to Steve in just a moment. So, David, let me ask you, your base case scenario here for what the Fed will do and say. Well, I don't think they're going to change their characterization of the economy in any significant way at all in the text.

But this is all about the dots. There is a risk that they reduce their estimate for rate cuts this year from three rate cuts to two rate cuts. It would only take two members of the Federal Open Market Committee changing their mind to do that. So that's one issue. The second issue is in the long run, they say the federal funds rate ought to be 2.5%. That's sort of their equilibrium number.

That seems low to a lot of economists and strategies. So there's a risk that that will move up. So I think everyone's going to be focused on the dot plot and the summary of economic projections today rather than what this Fed says in its statement in a few minutes. Kristen, do you agree with David? I absolutely agree with them. I would add two things to that, though, because I think it's interesting that going into this announcement,

we actually have the market has met the Fed, right? So the market is pricing in three rate cuts where we started the year at close to six. And so I think there's two other things to pay attention to. One, they're going to talk a little bit about balance sheet and quantitative tightening. We're not going to get the details on that. We don't anticipate until May. But if they signal that they've been discussing this, this is something that the market could actually react quite favorably to. And the last point is really around the data. What is

Chair Powell paying attention to in terms of inflation? January, February, we're not prints that we liked in terms of the disinflationary trend. But when you look at things like year over year for a full 12 months of core PCE, it could tell a different story. So we're going to pay attention to his data points as well. John Bellows, how much do some of those data points on inflation do you think worry the Fed? And I guess the second question, question would be, can the Fed cut rates before, maybe even well before, inflation gets down to that 2% level? Yeah, so I think it's possible the Fed's been a little bit discouraged by the inflation

day over the last two months. But, you know, in economics, things generally don't move in straight lines. So some bumps along the road are to be expected. I think the big picture remains unchanged. The big picture, as was just mentioned, as inflation's a lot lower than it was a year ago. You know, our expectation, I think the Fed's expectation is that it will continue to move lower in the months and quarters. You know, that big picture, that's the foundation of rate cuts. And I think that remains very much on track.

And as a consequence, you know, our expectation is that today the emphasis will be on that big picture and on the rate cuts still in the forecast. As again, you know, inflation is lower and that's the basis of the rate cuts. Yeah, of course, though, things have been fairly bumpy when it comes to these economic data points. And we don't exactly know what the Fed will say in the commentary, but that's going to be very important as we listen to all of this. And we think that there's just going to be a hold pattern. But we're going to find out when we go to Steve Leasman here as he gets ready for us to tell us exactly what the Fed is going to do. Steve, what do you got?

The Federal Reserve leaving interest rates unchanged at five and a quarter to five and a half percent. And leaving in those three rate cuts, predicting a year-end funds rate at 4.6 percent. I'll get back to that in just a second. They see the economy expanding at a solid pace, same as they did in the last statement. Inflation has eased but remains elevated. Same as the last statement. If there's a theme developing here, it is. Not much change.

Only one change, actually, about job gains, remaining strong, no longer saying they've moderated, saying the risk between employment and inflation goals are moving into better balance. They also said they still do not expect it will be appropriate to cut the target rate until that has greater confidence, inflation is moving towards. 2%, which is to say they don't have that confidence yet, and so they're not projecting when those rates might be cut. On the projections, pretty interesting here, big boost to the 2024 GDP outlook to 2.1% from 1.4. A tick lower on unemployment down to 4%. This is the 2024 year end. Two ticks higher on core PCE to 2.6% and yet more growth, more

inflation, lower unemployment. They left those three cuts in place of 4.6% for year end. They did skew a little bit more Hawkinson. I'll get to that in a second. I will tell you, they cut one rate cut away from next year. They went to 329 from 3.6 and for 2026 to 3.1, and a tick higher, by the way, in the long run rate. They say they remain highly tend to inflation risks and ready to adjust policy as needed.

I don't have a chart for this, but let me just tell you. In the January projections, there were five officials below that meeting of 4.6%. Now there's only one. So a lot of people who were more doveish came up and they're more in line with the committee. But it is an interesting question right now. The Fed sees more inflation, higher growth, and yet they left those three rate cuts in place, at least for this year, taking one away from next year. This was a unanimous decision, I take it.

Yes, sir. No dissents there. And as you say, it looks like there. There's a growing consensus among the members of the board around that 4.6% year-end number, right? That's a good way to put it, Tyler. Almost everybody, except for one person, is on board on 4, 6 or higher. I will tell you, though, that in terms of being above the median, there were nine officials in December, now there are eight officials above the median.

So it came down into, sorry, the other way around. Eight officials last time, nine this time, who are above the median. So they did skew. Remember, we needed two to get above the median, two more, and there was only one more. But what happened is the bottom came up to the median. So everybody has this, as you suggest, that consensus around that median of four, six, or the three rate cuts this year. All right, Steve, hang on. I'm sure come back to you in just a moment. Why don't I turn back to you, David? Any surprises here at all? I guess not. Well, no. I mean, by the skin of our teeth, I think they made the right decision here.

I mean, we could have lost two people moving that number up. We only lost one, so it stays at 4.6. If I was hearing Steve Wright, I think it's good that they are moving up that long-term projection of what a neutral federal funds rate would be. Because what have we learned over the last year? We've learned that the Federal Reserve can jack rates up to, you know, five and a quarter to five and a half. They can really slam the brakes on the economy in terms of monetary policy, and the economy can take it. And the economy can take it.

And also, inflation can come down even if unemployment's below 4%. So that says that maybe in the long run this economy doesn't need as much monetary accommodation. Maybe it's a pretty healthy economy on its own, in which case, why do you have such a low, long-term funds rate? So it's a more logical projection today than I think it was three months ago. How about that point, Kristen, that the economy, not just the economy, but the markets seem to have adjusted to the idea of fewer rate cuts and maybe a terminal interest rate that is a little higher than originally thought? I think, yeah, I took a couple of things away from what Steve was saying. I think the other thing to focus in on is the fact that the focus on the jobs market and employment.

Yes, the predictions kind of there is a slight uptick in terms of the unemployment rate, but overall that job gains remain strong, which means that the Fed's real North Star in terms of whether or not we will see that rate cut is going to be in disinflationary forces continuing. In terms of why the market has actually responded quite well, that goes back to normalization and fundamentals. And so when we look at, why is the market where it's at, it's due to earnings. We're expecting around 7.5% earnings growth this year, 15% over two years. That is actually quite strong, given all of the tightening that has taken place.

John, right now, if we look at the market reaction immediately, it is to the upside, ever so slightly so, but stronger, of course, to the upside than we were before we knew at least the Fed's decision with all the details still from the press conference. I mean, why is the market reacting as such? Is it just because there's no surprises? I mean, Steve said much of this was much as expected and there was not much change in the statement and the wording itself. I think there's two reasons. I think the first is that the consistency in keeping those rate cuts in the forecast, I think is helpful. I think if the Fed was instead kind of skittish and got a month of bad inflation and adjusted their forecast, that would signal a little bit of unease on the Fed's part and that would translate into. investors being uneasy. So I think that's one. I think the second reason is that, you know, two weeks ago when Powell last spoke, you know, many people, and we were impressed by his consistency, you know, the time for Powell to really shock the market and change expectations,

that's in the past. You know, that was necessary when we had a big inflation problem when he really needed to do a lot of work to get that under control. But today, he can be more consistent. He can be more stable. He can be less surprising. You know, I think that was the message two weeks ago, that would be the message today. And I think that will be the message, you know, over the course of the year as a more consistent, stable Federal Reserve. And I think that's actually helpful from a market's perspective as it allows investors to kind of set expectations and invest based on things like Kristen just mentioned fundamentals rather than trying to guess what the Fed's going to do. Rick, I know you're with us. Tell us how the bond market is reacting and what you took away

from what we've heard from Steve so far. Equity markets, they're happy as long as rate cuts aren't taken off the table. So they're happy. the bond market. Bond market saw 460 trade in twos, so it dropped a bit. It's back up to 462, down about six basis points. Tens, they traded down around 422, they're back up to around 4. A quarter, and I do point out both those rates are definitely lower than they were just several days ago, but they're definitely higher than they were several weeks ago.

In my opinion, the whole ball of wax probably leans on the unemployment rate, which I'm sure he'll get to in the press conference, if you recall, it moved up to three years. which means the last three months are 373739. 39 happens to be a half a point above the low in January and April of 23 which is 3.4%. And should we, the next jobs are you, get an unemployment rate and I'll guess what it is. My guess for the next unemployment rate is going to be 4.1% because 4.1, 3.9, 3.7, the three month rolling average there is 3.9%. A half a percent above the 3.4. It's the SAM rule. Boy, this has been brought up so many times over the last 36 hours, which basically states when the unemployment rate moves to a certain level, it seems

to accelerate a bit. The Fed's going to be paying very close attention to that. But don't believe your lying eyes. Pretty much, as Steve said, inflation's higher, growth's higher, and there's still pretty much three eases built in. All the markets are happy. But I'm telling you, as Sherlock Holmes fans used to say the games afoot. The Fed's really threading the needle on guidance here and public opinion. But in the end, can they really cut rates when growth and inflation are still this sticky? I'm not sure I believe they can. Steve, you want to react? Yeah, I mean, what Rick just pointed to is something that I'm sort of gathering a question on. And I like the way Kelly put it. By the hair of our chin-y-chin-chin, we escaped having that third cut go away.

it is interesting here, higher growth, more inflation. I think when Powell was asked about this apparent inconsistency, the way he will respond is to say, well, we think we're tight enough here in order to handle some upside, surprise, or less of a decline in inflation and more growth than we previously thought. And it's a measure of how much restraint

we think we're putting on the economy here that we believe we don't have to change our forecast or the average official doesn't have to change. their forecast. I think that's how he'll probably respond to that question, but I think it's coming out. I just want to remind folks, there's another shoe to drop here, an important shoe. We know the Federal Reserve began discussion, we were told anyway that they would, of the potential end to the reduction of the balance sheet. And so we'll hope to get some information and some details about when the Fed might bring quantitative tightening to a close here, having brought the balance sheet down

by a trillion and a half, but still remaining if it keeps going at this pace for another year, would even stop at $2 trillion above where it started this whole thing back in 2020. Very interesting stuff. And if I can go back to David Kelly when we're talking about the balance sheet, we don't have the details. As Steve said, maybe we'll get some here in the press conference. What feels appropriate to you knowing what we do about where the Fed stands right now? What should the timeline look like and what can the market take? Well, I think what's really interesting is the Federal Reserve really doesn't know how far they can push down that balance sheet before they have a repeat of what happened back in September 2019,

where short rates suddenly bounced up. They're using this ample reserves regime. It's right now, it's abundant reserves. They've got all these reserves. So they're gradually draining reserves from the system, but they don't know how far they can go. And they're really making some guesses here. I've seen some research coming out of St. Louis Fed saying that maybe if you get reserves down to between 10 and 12 percent of GDP, that might be right. But it seems to be very loose logic. But if they do that, yes, go ahead. Maybe you can answer a question for me. If they have the standing repo facility, which is like something you can, you know, a break glass in case of a fire here. In other words, if they don't have reserves, they can go to the Fed for those reserves. What's the difference? I'm trying to figure out a reason to be concerned. The Fed could go too low on the balance sheet if this standing repo facility is something that really exists and will work. Why should I be concerned? I agree with you. I don't think they should be so concerned. But they, but they're, I think they're worried that they will.

get blamed if they have a repeat of September 2019. There's no reason. They can mop up the mess very easily. I think that that's exactly right. But what's interesting is if you use that measure, you're quite right. I mean, they were $4.1 trillion of a balance sheet before the pandemic. They could stop $2 trillion higher than that. But if they do that, and this is what's going to be interesting from the press conference, it's possible that Chairman Powell will indicate that they may begin tapering this year. And I think that would be a positive sign for the bond market, because it says there's going to be a lot of support still at the long end of the bond market from the Federal Reserve. Kristen, why don't you react to the thoughts about the balance sheet and where the

equilibrium value might be and how far away are we from it? I absolutely agree with all the comments that have been made. If you look at where we were pre-pandemic, there's still a lot of room to go. We're at like $7.5 trillion right now. But I think that the market will actually react quite favorably to this. If we get commentary from Chair Powell, just the fact that there is a discussion around quantitative tightening and when we will see either the slowing of that or the ending of that, remember, that's adding liquidity into the system. So I think a lot of the things that we're receiving, whether it's the three cuts that are still priced in, a discussion around quantitative tightening.

And I go back to what I said earlier in terms of the data points that he's paying attention to because Chair Powell has shared in, whether it was congressional testimony, some of the other conferences, he has shared the fact that he is anticipating rate cuts this year that we don't have to break employment to actually get our first rate cut. And just to put all of this into perspective, we're talking about three rate cuts of 25 basis points. Those 25 basis point cuts are far from accommodative. And so I think we also just need to put it into the larger context as well. John Bellows, a final thought. You know, David highlighted the risk with regards to reserves. I think the other side of this is the point that was made is they bought a lot of bonds in

2020 and 2021. You know, they just expand the balance sheet tremendously. And I think that's going to mean that their bias is going to be to continue the QT for a while and try and get that back down. Again, they bought a lot of bonds. There's a long ways to go to kind of undo that. And so I wouldn't be holding my breath for them to start buying bonds again. They'll use liquidity as an excuse to stop.

Potentially. Steve, go ahead. Rick, Rick, what's the bond market want to hear from Powell when it comes to QT? Obviously, they want to know that there's a whole bowl of lollipops that are out there, which is, you know, we're going to have... Well, 10-year-node yields are already thinking about this. Okay, go ahead. Tell me what they're thinking, Rick. They're moving higher. And here's what they're thinking.

That quantitative tightening is going to stop well shy of any number. We're currently at what? 7.58 trillion. Last time we got as high as credit crisis, four and a half trillion, we came down to 3 and 3 quarters trillion. So the spread of where we're going to stop is going to be. be wide and it's going to stop because of the notion that the reverse repo parking lots getting empty and the bond market doesn't like if the balance sheet is much higher in my opinion than six or six and a half trillion, which in and of itself, as you pointed out, is still

two trillion higher than when they stopped after the credit crisis and you know they want to use that balance sheet again should any type of crisis develop in the future. And we all know the crisis calendar seems to have a higher frequency than he's. used to. How did I, how did I know that Rick would have an opinion on the balance sheet, guys? How did I divine that? Familiarity, familiarity, history, a long and glorious history. Thanks, guys. And ladies, appreciate it. All right, coming up, we'll get more reaction to the Fed's decision. And we're just minutes away, of course, from Jerome Powell's press conference. We'll take you there live when it begins at half

past the hour. But first, a quick break. Stick with us. Welcome back to Power Lunch, everybody. The Fed, leave. interest rates unchanged as expected and sticking with an earlier forecast of three rate cuts by the end of the year. Here for his reaction is our friend Dennis Lockhart, former Atlanta Fed president. Mr. Lockhart, good to have you back with us. I guess I don't see much in the statement or the action, which is a non-action, to suggest that the Fed is becoming more hawkish. I'd like to get your reaction to that. But I do sense that maybe they're just becoming more patient, which is not necessarily a bad thing. Yeah, I think your conclusion is correct. I would,

would say, however, if you look at the dot plot, you do you do see some movement in the dots? There were, I think, four at four dots, that is four moves, and they have all but one have moved into the three category. The consensus is pretty tight around three moves this year, and I think that's the take. away that the consensus has tightened. What about the big boost to the GDP forecast, a 2.1% from 1.4%. What do you make of that? And is that sort of the Fed setting themselves up for saying, look, the economy is getting stronger.

That's why we've got these three cuts planned. Yeah, I think they're recognizing that the underlying demand in the economy, underlying strength is pretty robust. and that's why I think they're sticking with three rate cuts because they see that they have that strength of the economy to deal with. Take us inside the meeting. Since the last meeting, we've had a couple of inflation numbers that have been to some a little bit worrisome.

What is the discussion like about numbers that were above what Wall Street and economists were forecasting? Well, they're not dismissed, but they're looked at in the context of being, you know, just one report or one or two reports. So there's not generally not an overreaction to that. I think, as J. Pal has said frequently, there's no expectation that this disinflation will be linear and it just will come down in an even fashion month over month over month. So I think they reserve judgment, and I believe that the reports we've seen recently, to a small degree, reset the clock because they need to look at another two or three months of inflation reports, be sure that what they're seeing is just a bump and not something that's signaling a real change of direction. And that's sort of what I was going to ask is how many reports do you need to see in a row to consider it a pattern for inflation? for instance. Obviously, inflation has sort of been this sticking point. And how do you know when it's

just a bump or it is a new trend that the Fed should take appropriate action on? I think different members of the committee might have different answers to that. I would personally say I would be looking for three to fully interpret what's gone on with the January and February reports. So it would be, you know, past, in all likelihood, the May meeting. Is there an unemployment number? Rick Santelli just mentioned the idea that unemployment is about a half point higher than it was at this time a year ago. His prediction was that it may go above 4% on the next number that comes out in about 10 days.

Is there an unemployment number that would cause the Fed to begin to worry about that? Because full employment is part of its mandate? Well, first, there are good and bad reasons why unemployment numbers rise. When you have people coming into the workforce and increasing participation, that's a good reason for the unemployment rate to rise. So they would look within the numbers to see what the dynamic really is. But if you're seeing layoffs and you're seeing widespread downsizing of companies and so forth, beyond 4% would begin to, I think, get the attention of people on the committee. How do you characterize the economy that you see?

Atlanta Fed, the Atlanta Fed has typically been sort of one of the more emboldient forecasters of economic growth. What do you see around you? I see a solid economy that is slowing from a very, very strong third quarter of 2023, somewhat less strong but still strong. fourth quarter. And this quarter, if you believe GDP now, the Atlanta Fed's tracker, is coming in more around 2%. So that's a slowing top line growth number. I see a very healthy labor market. And I see inflation going sideways at the moment. So there's a bit more ambiguity around the total

picture, particularly the inflation picture, than we would have had too much. bunch ago, for example. Mr. Lockhart, always a pleasure to have you with us. We thank you. Dennis Lockhart. We are just moments away from Fed Chair Powell's press conference. We will take you there live as soon as it happens. Been anticipating this all week. Power lunch is back in two. Let's get some final thoughts as we count down to Fed Chair Powell's press conference. David Kelly of JP Morgan Asset Management is still with us. David, it seems to me the risk is pretty low right now for the Fed to hold these rates unchanged, which is we know what they

did. What is the risk, though, of cutting potentially too early? Is the bigger risk a chance of reigniting inflation? No, I don't think the Fed's going to reignite inflation by cutting rates at all. I mean, there's a lot of talk about the neutral rate of interest, but the truth is, I think interest rates have much more of an impact on financial markets than the real economy. We've seen all this tightening last year. It didn't do anything to slow down the economy. So what I'm interested to hear from Chairman Powell, apart from obviously quantitative tightening, I'd like to hear why they pushed up their estimate of economic growth this year, because it does seem that they're looking for a lot of employment growth powering this in an economy where, you know, the growth in the native-born population is pretty slow.

So I'm wondering, is there an immigration component to this? If they're thinking we're getting a lot of immigrants maybe coming in in a very chaotic fashion, but adding to the labor forces, that's what's pushing up their growth targets. Is that why they think this economy is capable of growing this strongly without actually pushing up inflation? You mean growing to that 2.1 percent, the GDP marker? Yes, exactly, because that's above their long-term estimate of economic growth. and why they think we can do that. I mean, I think we can, but I'd be interested to know why they think we can do that, given their sort of previous calculations on the issue.

Let's talk a little bit about quantitative tightening and where. I mean, Rick sort of gave the idea that wherever they stopped, they're going to be higher than they began in terms of the size of the balance sheet. Yeah, I think they are. And I think that's because they've got such a complicated web in their ample reserves regime They've got all these regulations on the banks. They've got the Treasury Department changing their behavior. They've got what individuals do in terms of holding currency.

It's extremely complicated for them to figure out what's ample. So their view is, and Chairman Powell said this, is they want to stop before they reach ample. But since they don't know where ample is, they'll likely to stop short. So that's actually good news for the bond market. It means there's a lot of support from the Treasury Department, sorry, from the Federal Reserve, in holding down those long-term interest rates. It's good for the bond market.

I don't think it has much impact on the economy overall. though. We're seeing a lot of the bank ETFs jump, so the KBE is higher by more than a percent here. Obviously they do well in higher interest rates environments, but the Fed is still holding steady on the idea of three potential rate cuts. So what do you think

why do you think the market is so excited at least in the financial bank sector to see what we've heard so far? Because what we've got is patience in predictability. The beauty of three rate cuts is you do it in June, you do it in September, you do it in one of these meetings where you release the summary of economic projections,

people can kind of figure out what you're doing. If they'd gone to two rate cuts, then there's a lot of uncertainty. Was that July? Is that September? Could this all vanish? So so long as they are patient and consistent in what they do, that I think helps financial markets in general. So do you see three cuts this year beginning in June or what? Yeah, I do.

I think they will have enough evidence in underlying core inflation coming down by June to justify a first rate cut. Because remember, we're very tight. And I think they can give us another rate cuts in September, another one in December, and then we'll see about 2025. I think they can keep going for a while here, but I think they'll just wait for the evidence. But I think they'll have enough evidence in June to start this process. And as you say, you're not concerned about a rate cut reigniting inflation.

No, because this economy is actually pretty good at growing at a solid pace without causing inflation. We've had inflation come all the way down from 9.1 to 3.2. Without economic growth slowing down, we've had 27 months with the unemployment rate at or below 4%. And yet inflation is still basically being cut. to a third of what it was back in June of 2020. So this is a pretty impressive economy, and I think the Fed can kind of do its thing here, and that's, I think, good news for everybody.

All right, David Kelly, thank you very much for your time today. We don't have Chair Powell yet, but why don't we just take a look at where the markets stand right now? The Dow and the equity markets have basically gone from flat to what I would characterize as a very modest gain of about 4 tenths of a percent for the Dow, a little more than that for the NASDAQ, and a little less than that.

for the S&P 500. The 10-year bond yield at 4.29% and there you see it dipping earlier today, now back up 4.29%, 4.27.