Power Lunch - Fed holds steady, but rate cuts coming? 12/13/23

Episode Date: December 13, 2023

The Federal Reserve held its key interest rate steady for the third straight time, but also set the table for multiple cuts to come in 2024 and beyond.Along with the decision to stay on hold, committee members penciled in at least three rate cuts in 2024, assuming quarter percentage point increments. That’s less than market pricing of four, but more aggressive than what officials had previously indicated.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, everybody, to a special Fed edition of Power Lunch alongside Kelly Evans. I'm Tyler Matheson. We are just minutes away until that Fed decision on interest rates. No change is expected, as you probably know, but we'll be looking for hints on when the Fed might start cutting interest rates in its text. And let's get a check on the markets heading into that event. You can see tiny increases of less than a tenth of a percent across the board, Dow, S&P, and NASDAQ. And bond yields, meanwhile, are creeping low. lower, especially after that cooler than expected producer price index this morning. All right to our all-star panel, as we are still minutes away from the Fed decision.

Joining us, David Kelly of J.P. Morgan, Kristen Bitterly, of City Global Wealth, John Bellows of Western Asset. Lady and gentlemen, thank you for joining us and welcome. David, let me begin with you. What do you expect the Fed to do? And what do you expect them to say? Well, I don't expect them to change rates. I think we're done with tightening. I think the, and I don't think the statements will change that much either. I think in his press conference, Jay Powell will sort of celebrate better than expected numbers for

2023, but sound cautious on 2024. But I think the really important thing is the dot plot. I suspect that they won't actually move the end of year 2024 number, which would mean, okay, we don't get any further rate hikes, but they only cut once in 2024. And I think that'll be an expression of caution about 2024, an expression that they really do intend to keep rates higher for longer. So I don't necessarily think that's how it's going to turn out, but I think that's going to be the messaging today. Kristen, how about you? What do you think they will do or say? And why don't you pick up on David's point there about the so-called dot plots and how much the Fed might be inclined to cut in 2024?

I think that's the major question on everyone's mind. This is going to be the third time that the Fed is going to pause. So effectively, everyone knows at this point that they're done in terms of the hiking cycle. And everything is, about when are they going to ultimately cut and this disconnect in what the markets are telling us where, you know, we have north of 100 basis points of cuts priced in at this moment in 2024 versus what the Fed is anticipating anywhere from one to two cuts. And so I think it's going to be a game of connecting the dots in terms of the messaging and looking overall, you know, is the market getting a little bit ahead of themselves both in terms of the number of cuts as well as the timing, because we still have close to a 40% probability that we could see that first

rate cut within Q1. So I anticipate Chair Powell is going to, again, point to the data that we're seeing both in terms of inflation and employment in terms of maybe walking back some of those expectations. And John Bellows, do you think he's going to walk those back or not? You know, I'd like to focus on the core PC forecast where you get today. You know, based on the PPI numbers, Kelly, that you just mentioned, I think that core PC forecast, forecast is going to come down for this year and potentially for next year. You know, in fact, core PC over the last six months is actually running at 2% or if not a little bit below that. So this is a big deal.

You know, we've seen very, very good inflation numbers. I think that's going to be the conversation today. There's a lot of focus. And the other two have talked about kind of the timing of first cuts. I think the bigger question is if inflation really is at 2%, why do we need these elevated interest rates at all? And, you know, I think it'll be interesting to hear him address that question today. And I think in some sense, that's more important than the timing. is why do we need these high interest rates at all if inflation, in fact, is it 2% already?

John, do you think the, how much do you think the economy is going to slow in 2024, and how will that affect what the Fed does? You know, I think we had an exceptional summer in the United States, obviously, with that 5% in the third quarter. I think that was the anomaly. I don't think it's right to extrapolate that going forward. I think the moderation that we've seen in November and, you know, into December is more likely going forward. So I think the economy is going to moderate.

I think interest rates are high, and we think that will be a drag. So some moderation, certainly not what we saw over the summer. I don't think that means we have to have a recession, but definitely moderation relative to where we've been. How about you, David Kelly, on the economy's strength, 20 seconds, please? Well, I think the economy will sit down to about a 2% pace, but I think the really interesting thing on John's point is, I think headline PCE deflator could come very close to 2% in the second quarter, and that's going to put pressure on the Fed to begin cutting at their June meeting. All right. Well, that's very interesting.

Let's take a final look before we get the word at the markets there, basically flat most of the day. No surprise is expected here as we get ready for the Fed decision, the release of its statement and the decision. And for that, we go to Steve Leesman. The Federal Reserve Leaving Interest Rates unchanged at 5.5.5% to 5.5% a unanimous decision in the December meeting. The Fed says growth has slowed from the strong third quarter pace, saying inflation has eased over the past year, but remains elevated. It is the first time they said anything positive about inflation for a very long time in the statement. And they backed off somewhat their bias to hike, saying it was now determining the extent of any additional policy firming, inserting the word, inserting the word any into the statement for the first time.

They lowered their 2024 Fed funds outlook to 4.6. percent from 5.1 percent. So half a point down forecasting on average for a Fed official 80 basis points of rate cuts next year. It had forecast just 50 basis points from a higher level. Of course, they got rid of the expectation for an additional, the forecast for an additional rate hike this year. That's gone. They lowered their inflation out for this year to 3-2 from 3-7 for core PCE. That's down by 50 basis points. They hit their 2% inflation target now, maybe a little little bit earlier, sort of towards 2025 or the end of 2025, and they see below trend growth of 1.4% next year, a 10th less than the September forecast. Unemployment rates seen at 4.1

next year, about 4 tenths higher than the September forecast, and they repeat in the statement that job gains have moderated but remain strong. Now, there's something in the dot pot that I think is worth pointing out. While that median did come down from 5-1 to 4-6, there are five Fed officials who are below that 4-6 number, who see a full 100 basis points of rate cuts next year, and they're even more doveish in the 2025. If you remember the September forecaster had been at least one Fed official who was above 6%.

That's gone. And the top of the dot plot now for next year is now 540. So I would say that the Federal Reserve today took a step towards the market, rather than the market taking a step towards the Fed. I wouldn't say it's an all clear on this, but the Fed definitely backing off plans to hike additionally or making certain other plans to hike and also forecasting more in the way of rate cuts next year for the average Fed official than they had in September. Tyler? And we are seeing Steve about the clearest market reaction we've seen to a meeting in some time with stocks shooting higher. It does up about 150 points right now. And the 10-year yield just sank, gosh, almost 10 basis points.

13. You can see 4.07 is the intraday. On that note, let's get over to Rick Santelli for some reaction here, Rick. Yes, 415 is where we were right before the number came out. We're at 406, 407. Obviously, we've been down

rather aggressively to drop two-year note yields getting down to a 453 level. They were around 467, so about 13, 14, 14 basis point drop. I think what is noteworthy here is, if you look at the PPI in particular today.

There's very little doubt that we see inflation showing. And the new game in town is to, of course, look at the current monthly rates and annualize them over three and six months. And if you pick the right inflation indicator, maybe the Fed's favorite PCE, yes, you can play with this date and get it very close to the Fed's objective. Well, that's all fine and dandy. And I do think that will afford them the ability to come somewhere between the market. 80 basis points, 110 base points, whatever easing, many see.

And it is an election year, and it certainly seems to be baked in the cake. The problem is that as we look forward through the windshield with these annualized, very specific inflation metrics, the real issue for Main Street America is the windshield looks optimistic because all the inflation is embedded in the rearview mirror. We have compounded and solidified many of the price increases in the system. Moving forward, that rate of increase might move to zero and afford the Fed the ability to slow it down. But I continue to think of things like the Writers Guild strike. The auto workers up 25% over four years.

Vegas casino workers first year, 11.3% increase. Airline pilots, 34 to 40% increase. If we look at what's going on with UPS, 170 grand a year with benefits and pay increases. The reason I mentioned this is those obviously are in the rearview mirror as well, but they have set up a footing of pricing issues that will continue to hurt the market with regard to more workers, of course. And I'm not saying it's a bad thing, but there's going to be ongoing pressure for many others to continue to boost pay. And I think that cycle isn't going to be going away as quickly, even though the Fed will have the ability to lower rates in the future. Bob Bassani, what would you add as we look at the Dow up 176 points right now?

I think Fed's right. The Fed has moved towards the market, and that's certainly very good news, because the pain trade was down. Remember, we've moved 10% on the S&P since the last Fed meeting. It's moved on expectations that Powell would acknowledge inflation and the effects of lower inflation, that the PCE estimates, for example, would come down, and they would make some acknowledgement of progress on inflation. Look what we've got here. We have a Fed statement talking about slowing, economic activity slowing from being strong,

in determining the extent of any additional policy affirming. That's a very strong nod to the doves that are out there. And then a nod with the PCE estimates coming down as well. This is about as dove as you could have possibly expected from anybody. The real concern right now for the markets is just how far it's come. The stock market is overbought on exactly these expectations. The Fed is delivering what the market thinks. The worry now, the concern for the markets is that the inflation data does not come in line with the expectations in the next couple of months.

Right now, though, it's about as Goldilocks as it gets. Bob Bizani, thanks very much. Kristen, I want to come back to you because as you were speaking there before the meeting, I found myself thinking, well, what you're saying sort of sounded to me like the market was expecting more than the Fed has indicated it is likely to do. But as Steve pointed out, now it looks like the Fed has come closer to what the market has been expecting. That's exactly what I heard as well. So, you know, the question going into this was, was the Fed going to meet the market or was the market going to meet the Fed? And it looks like the Fed has kind of bridged that gap in terms of meeting the market at least, you know, three quarters of the way in terms of what was priced based on the dot plot.

I think that, you know, some of the things that we're going to look for within the press conference. So obviously these comments about inflation and the first nod to inflation coming down and recognizing that. We've seen that in the data. We know some of the lagging components. You know, when you take out shelter, we're actually at that 2% target in CPI. And so a lot of people are looking through to that underlying data. So the fact that the Fed has acknowledged that, I think the interesting thing that we have to

look for within the press conference, though, is given the comment that was just made about how far the market has come, is Chair Powell going to give any consequences? commentary about the loosening of financial conditions, just given the market rally and also the movement that we've seen in rates as well, which then kind of brings us full circle in terms of really the timing of this first cut next year. John, let me turn to you because it appears that in their forecast for the economy next year, the Fed governors as a group are coming to where you are. That is a slowing economy, 1.4%, which is a lot lower than it's been this year. year. Yeah, and I think that's especially true on the inflation side where it sounds like they did

downgrade their core PCE forecasts. You know, I think it's mostly about inflation here. I think that the tightening or loosening of financial conditions may or may not be appropriate, but as long as inflation is lower, you know, that's what the Fed's going to respond to. The Fed's a bunch of economists. They have an inflation mandate. They're focused on inflation. The news on inflation's been good. And I think they're reflecting that here. And should that continue to be the case, would reflect that through lower rates over time. So I think it's right to focus on inflation. I think that's the takeaway today.

And I think that's going to be the takeaway going forward as the improvements on inflation are significant. They're being reflected in the meeting today. And they will continue to be reflected, you know, should they continue through lower rates in the future. Stocks across the border up about half a percent, the 10-year note, around 4-10. And I think someone made the point earlier, Steve Leesman,

that, you know, falling rates and these kinds of things help ease financial conditions, whereas previously rising. rates were tightening them. My question to you is going to be now that the Fed has moved to where the market is, does the market just keep moving further into pricing in yet more rate cuts or more loosening or more easing of financial conditions next year? Yeah, Kelly, that's just a bit of cable television ESP right there, because that's exactly what I was going to talk about. That here's what happened. The Fed moved to the market and the market moved away and further from the Fed. I was actually looking at the probabilities for March, which had been, you know, around 40% probability for a cut.

It's now 62% for May. It's 90 basis points. And I hate to do this live on TV, but yeah, there's the January 2025 contract, which sees 4.05. So there's about 135 basis points of rate cuts built into the futures credit. That's the problem. And we may be back to where we were again, where, okay, the Fed is taking a move 20%. The market's taking to move towards the market, and now the Fed may have to rein expectations back in.

Again, we're going to have to watch the data. The inflation data, John is right, is what's going to determine what happens here. There are good reasons to expect it to come in, but the data actually needs to perform for the Fed to do what the market wants it to do. David Kelly, your thoughts? Well, we waited all year for the Fed to pivot, and finally, as a Christmas present, they give us a pivot.

it. But I would, you know, I do believe the inflation numbers are going to be good. I am a little worry that the most dangerous time for the economy is when a tight Fed begins to ease, because, you know, those rate cuts aren't just sending a message to the market. They're sending a message to the economy. And a lot of people, if you think there's going to be much lower rates at the end of next year, you really want to borrow money now? You want to wait a while? And I hate it when everybody decides to wait a while. That's very bad for the economy. So good news today, I think, for both the bond market and stock market, but I'm just a little bit more cautious on growth. Now the Fed is finally pivoted to an easier position.

That's an interesting point, that it could have a kind of inverse effect. In other words, when you cut rates, that's supposed to stimulate the economy. But when you cut rates, you may be causing people to put on hold their borrowing activity. They might wait because they figure, well, mortgage rates are going to be lower a year from now than they are now, or a company might wait because they figure they can get a better price on bonds or better interest rate on bonds a year from now than they do today, David. it. Yeah, exactly. Raising rates from very low rates doesn't actually slow the economy, as we've seen many times, and cutting rates from very high levels doesn't actually stimulate the economy.

So I think the economy looks okay right now, but I'm a little bit more nervous about it. I feel confident inflation is coming down, but I do see that slow down in growth, and I'm just a little bit more concerned that it would become more extreme as the year goes on. And I think that may be why the market's pricing in more aggressive rate cuts next year. Bapazzani. You know, Sarah was speaking with Janet. Yellen this morning. And Yellen made a very, I think, strong case for the soft landing. I think she made very compelling argument saying one of the reasons that I'm getting into the soft landing camp, she said, is because in the past, inflation expectations were not well anchored,

like in the 1970s, or were well anchored, expectations that inflation was going to be higher for much, much longer. And she made a case saying that is not what is happening here. And that is one of the reasons we don't feel the need that there's going to have to be suddenly high unemployment. She case for the soft landing on the idea that inflation expectations from higher for longer for a long time is not going to be happening she got a little present here from the fed i mean in pcee core 2.4 percent it was 2.6 this is for 2024 fed funds for six uh that's a quite a drop uh 0.5 percent from prior expectations so the federal reserve obviously has some expectations as well that that inflation is not going to be some kind of permanent part of the landscape so the

Yellen, I'm sure, is quite happy with what she sees here from them. Rick Santelli, if you were going to give a grade to the Fed and its statement here, what would it be? Well, I think so far I would probably give it a B minus or a C plus. The problem I see is X food, X energy. Now many of the guests on CNBC are saying X shelter. So basically, X inflation, we have very little inflation. I think that when you consider the idea that over the next couple of years, we have a rollover of debt, the interest rate that we pay to service the debt's going to take a big jump in about that same time period,

that I think this is the big end of the world party that the Fed's raising rate cycle is over. I don't have a problem with that. But to think that the market rates, especially in the long end, don't have a possibility to be moving up after we get through the election next year and have to reckon with some of the big issues we have on servicing the debt in the budget, believe me, we should enjoy the fact that we're putting some cushion in markets like the equities because there's going to be some tougher sledding in about three quarters from today. I guess that leaves us with the question, and Kristen, all directed to you. What are you going to hope to hear or not hear from the Fed chair when he begins speaking?

So I think we just have to bring all of this together in terms of remembering that, while he did give a nod in the statement to inflation, he also pointed to the strong labor market as well. And so we have to look at these two things. And I'm going to bring this all back to the fact that, yes, the inflation data is going in the right direction. But there is the potential for the market to get a little bit ahead of itself in terms of when we anticipate seeing those rate cuts. And I think most of what we've heard today is this idea that we're not expecting, that a soft landing is possible. We're not anticipating a recession, but we are expecting a slowing of growth. And so that's going to ultimately show up in the data and particularly in employment. And that would be the signal to the Fed to ultimately start cutting rates.

So I'm going to look to those signals overall in terms of that balance between their dual mandate of, yes, inflation is going in the right direction. But let's talk about the labor market as well, which should give us more signals as to what we should be pricing in for next year. All right, Kristen, thank you very much. And thanks to our entire panel, John, David, Steve, Rick, Bob, everybody. And we will be watching throughout the rest of the afternoon to see what the Fed chair says. We'll obviously see Steve in the room. We're just minutes away from Jerome Powell's press conference. We will take you there, as I mentioned, as soon as it happens, and Steve Leesman will be in the front row.

But first, we will get more reaction to the Fed's latest decision after the break. So we'll be right back. Stay with us. The breaking news is that the Fed has left interest rates on change. for the third consecutive time. Pause, pause, pause, but signaling that several rate cuts may be in the offing next year. Let's get some reaction from Dennis Lockhart. He's been in the room where it happens, former Atlanta Fed president. Dennis, welcome back. Good to have you with us. What do you take from the statement and from the action? Action was no surprise. I don't think anyone

really expected that they would raise rates at this meeting. So no big surprise there. I expect a little bit more in the statement that a little bit more of a nod to the disinflation that we're seeing. It was a minimalist statement. It didn't say much at all and didn't change much from the last meeting. Did say inflation eased but is still positive. I mean, that's sort of covering both sides of it, I guess, you would say politely. Yeah, I would, you know, to my reading, a quick reading, it basically repeated much of what was said in the last meeting.

So, you know, it may be a signal that they really don't want to communicate a lot that will inform markets at this particular juncture and they want to wait until next year. Well, they did sort of inform the market. At least the market feels informed because the stocks have been moving up and you'll, you'll on the tenure where I went, went down. To the question of when or whether the Fed and by how much the Fed might cut rates next year, how do you interpret what they said today? I mean, I think that the Fed Fund futures markets indicating a higher probability of cuts beginning sooner in the year. Well, I looked at the summary of economic projection dot plots, the notorious dot plots, and it struck me that there isn't a tight consensus on the number of cuts next year. The great majority of

the committee, of course, is projecting cuts, but they range from two cuts to four cuts. And so when you look at a median, a median is just sort of the middle point of that range. So I don't think they're showing that they have a, at this point, at least, a real tight consensus around how many cuts next year. Dennis, this might be a little unfair, or maybe it's just a blatant statement of the obvious, but it seems that markets have been in the driver's seat of, you know, and basically telling us, yeah, this is what the Fed's going to do. I tend to agree with that. And the markets have a tendency to get ahead of the policymakers. The markets and market practitioners work on a somewhat different logic, and that is to anticipate early. That's how you win. Whereas the policymakers are probably

more inclined to be cautious and to wait and to make sure that in this case, they have inflation under control, which is a bias toward more inaction in the near term. And so there could be a disconnect here between market anticipation of cuts and what the Fed is really thinking. And I wonder if the chair is going to look at the – do you know, does he see the market reaction before he goes out to give his remarks? Because he might look at this and go, whoa, whoa, whoa, wait a minute. I better dial this back. Well, I'm sure he sees the market reaction, but I don't think he improvised is a great deal. I think his responses to questions and his commentary at the beginning are pretty well prepared and scripted. and he's not going to freelance when he's up there.

So it's hard to react to at least initial market reaction just on the spot. And I think his mindset would be markets will be markets, and the initial reaction may not be how it settles out later today or tomorrow. You say that in your view, a soft landing for the economy remains plausible. We had a guest on yesterday who kind of made the case that we're probably in that soft landing right now. How do you react to that? I think that case can be made. We are seeing disinflation and disinflation that has exceeded expectations.

We have a very strong labor market, very healthy labor market, and growth is slowing, but it's still positive. That's sort of a definition of a soft landing, is that you don't do great damage to the employment picture. You keep growing, but you get inflation down toward 2%. So yes, we probably are in the beginning of what could be a soft landing. Although, do all soft landings look that way, you know, or our hard landings look soft at first, you know? Yeah. Yeah, you know, you're raising an important point.

This is a jargon that we use, try to summarize a picture that is much more complex than simply one phrase. And take some time to play out. We all have to kind of adjust in the meantime. Dennis, thanks for. for joining us. We appreciate it today. Thank you, Kelly. Former Fed official Dennis Lockhart. We're moments away from hearing from the Fed chair himself. Chair Powell begins speaking half past the hour. We're bringing to you live as soon as it happens. We're back after a quick break.

Welcome back. Let's get some final thoughts as we count down to Fed Chair Powell's press conference. David Kelly of JP Morgan is back with us. David, let's just give the market action. It was a quiet day earlier, not so quiet right now. It's not a huge rally, but a pretty sharp one as the Dow has jumped about 200 points after the Fed move, and interest rates have dropped. Let's take the 10 year by almost 10 basis points. What's the significance of that? And do you expect the Fed chair to push back on it at all? Well, I think in the Q&A session, I think he will try and push back in it a little bit. I think if you look at the summary of economic projections, yes, they say that the federal funds rate could be between four and a half and four and three quarters by the

end of next year. So that implies three rate cuts. But he could say, look, look, even if that's right, that could be in June, September, December. So we've got a full six months at least based on the SEC before we would have to think about cutting rates. So I think he will try and push back, say, look, for right now, we're not sure that we're done with rate hikes. We're not sure that we're there in inflation. It's too early to say.

So I think he'll be pushing a lot on that, even though this was a relatively devish statement and the markets are correctly responding to that. Do you think he's theoretically on board with the idea of cutting rates as inflation falls, even if the economy hasn't slowed down substantially? Well, you know, in theory he is, but of course, you know, the Federal Reserve is historically late in every move.

So, you know, they may find some excuse. It's like, you know, everybody's got a friend who's always late for an event. And no matter how much they promise you they're going to show up, they're going to be late. Well, that's like the Fed. So the Fed, they're going to promise they're going to be, you know, respond to inflation, but I think they'll still mostly be thinking about, okay, inflation's getting better, but do we really need to move yet? and that'll tend to delay them a bit.

My wife and I are those guests. Terminally late. But I come back to it and I mention it every time, David. When we began this rate hiking cycle, you said typically the Fed is too slow to move, then they stay too high, too long, and they wait to cut too long, too late. And so that is really what you're driving at here yet again and correctly, I think. Well, yes, because, I mean, the economy is growing more slowly, but what this economy has proved in 2023

is you can have strong growth, you can have below 4% unemployment, because we've been below 4% for two years. You can have all of that with inflation coming down. So, you know, why mess with that by keeping rates this high? Let me ask you a political question. Why does Joe Biden seem to get no credit and only blame for where inflation is and for the fact that inflation has come down?

Why does the administration seem to get no credit for low unemployment and really relatively strong growth. Why? Well, you know, I think part of it may be, you know, the clarity of messaging, to be honest. You know, I wonder if, you know, if Ronald Reagan or Barack Obama were, you know, making these, had the same economy, whether it might be a little clearer. But, you know, I don't really want to get into the political judgment here because I think the other thing is I think people are exhausted after the pandemic. I think people don't think about inflation.

They think about high prices. And they still require the price of a lot of things they bought a few years ago. That's exactly right. I mean, it's not as though the price of groceries has come down dramatically. Just the rate of growth in those prices has slowed, which I suppose is a good sign. But it's not as though my $16 bottle of per sill detergent has come back down to $12 a bottle. Well, that's right. But when you look at financial markets, it really matters for the price of the financial assets, future inflation, not current prices.