Power Lunch - “Modest” Progress On Inflation, Only One Cut Coming? 6/12/24

Episode Date: June 12, 2024

The Federal Reserve kept its key interest rate unchanged, and signaled that just one interest rate cut is expected before the end of the year.With markets hoping for a more accommodative central bank, FOMC policymakers took two rate reductions off the table from the three indicated in March. We’ll break down exactly 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.

Good afternoon, everyone, and welcome to Power Lunch alongside Kelly Evans. I'm Tyler Matheson. Glad you could be with us, and we are just minutes away from the Fed's decision on interest rates. Let's get a check meantime on where the markets stand. The S&P 500 and NASDAQ both hitting records today up more than 1% each. Apple shares continuing to rally following its AI announcements on Monday. I guess the information is starting to sink in there. The stock gaining nearly 10% so far this week,

which is about $300 billion worth of market cap. Just extraordinary. I'm excited about the Fed, but I'm really excited about that Apple story. Okay, here's the 10-year as we head into the decision, 264, the lowest since the beginning of April, after this morning's CPI data came in lower than expected and raising hopes that the Fed might turn to PCE data later this month and see a similar downward trajectory.

The market now pricing in only two rate cuts this year, or as many as two rate cuts this year, I should say, after that release. All right, let's get right to our All-Star panel, as we are just minutes away, as we mentioned, about two minutes away from the Fed decision. We've got Kristen Bitterly of City Wealth, David Kelly, of J.P. Morgan Asset Management. Michael Kushma of Morgan Stanley, asset management. Let's go around the horn quickly. Michael, what are you expecting the Fed to do? I can anticipate, and what do you expect it to say? Well, I expect them to make no changes in terms of the interest rate strategy. but talk about inflation is now doing a little better than it was before. They highlight it last month that inflation was disappointing.

Probably take that out and not comment on disappointing, but that we're making progress, but not enough progress going forward, and that we're still on track for rate cuts at some point later this year. But you think that it opens the door a little bit, but you're skeptical that there will be a rate cut this year. Am I correct? I'm skeptical there'll be more than one, But I will be the first to admit that today's inflation data was quite shockingly low.

Maybe it's just a correction from the excessive numbers, maybe we saw earlier this year. But if we averaged them out, inflation is still reasonably perky. Although still coming down on a year-on-year basis, there's a stalling out of inflation, which would suggest a go-slow attitude with regard to rate cuts. Kristen, what do you think? And I'm tickled by that reasonably perky characterization. So I would agree in terms of inflation. It gave a little bit of relief this morning. And I'm looking for particularly within the statement as well as as well as the conference, more information about the employment backdrop. Because we did get conflicting signals, whether you were looking at non-farm payrolls or whether you were looking at joltz. There is a cooling that's happening in the labor market, not a contraction, but a cooling. And I think that Chair Powell will give us some signs as to how they are viewing that, which will then determine the trajectory of whether we get you know, two or three rate cuts this year.

David, give us about 20 seconds of thought. Okay, I think the dot plot will show two rate cuts as opposed to three rate cuts in March, but that's not too bad. I think they'll say there's less progress in inflation, but not a lack of progress in inflation. So I think the messaging will be reasonably dovish. I think they'll be encouraged by seeing some moderation and inflation. I still think we'll get a first cut in September. I said 20 seconds, and you hit it on the nose.

Thank you very much. David, we'll get back to you in just a little bit. And meantime, let's go to Steve Leasman now for the Fed's eagerly awaited decision on interest rates. The Federal Reserve in its June meeting leading interest rates unchanged and continues to say that it won't be appropriate to cut interest rates until it's gained confidence that it's headed towards its 2% target. The Fed, on average, now projecting one rate cut this year down from three in the March forecast. four officials, in fact, are projecting no cuts this year up from only two in March. One official actually says no cuts this year or next year, no cuts for you. They are projecting five cuts through 2025, which is down only one.

So they kind of get it done over the same period of time. Just the near-term cutting is much less. And I'll get back to that in the second. On average, they projected higher-of-fed funds rates this year and next. And, of course, interestingly, in the long run, the neutral or long-run rate, now up another two-tenths now to 2.8 from 2.6%. They only accounted for the recent progress for this morning's low inflation, by the way, along with the good numbers in April, saying there has been modest further progress towards the Fed's 2% target on inflation.

They had noted a lack of further progress in the March report. GDP outlook on change at 2.1% this year, 2% next year. The Fed's saying economic activity continues to expand at a modest pace, same language it used in the May statement. unemployment rate forecast was unchanged at 4% this year, a tick higher for next year that had previously been forecast at 4.1%. That's, of course, interesting because we're already at 4%. They did say in the statement unemployment is low and the job market is strong. Core PCE, interesting here too. The average for officials now is at 2.8%. Up two-tenths, even though the street estimates after this morning's report are that it will come in at 2.6% this month. So they're

projecting, in fact, a degradation or an increase in inflation this year on the core. In fact, only three words were changed in this policy statement when it came to the economy and the policy sections on it. And that was about the inflation that I read already, otherwise a carbon copy. Guys, an idea of how hawkish these projections are, I will tell you this. And you can write this down at home if you're playing. There were 10 officials in the March projections at 4.625 or below in March. Now not a single one is there. They're all above 4.875 for this year. So it feels like either they ignored the progress on inflation this month or last and last, or there was some kind of a coup of the hawks in the Fed committee room this meeting. All right, Steve, stick around and

let's get back to our panel for some reaction here. Let me begin with you, David, if I might. Is the market likely to like what it's just hearing? No, it won't. I think I think the market will have been responding to better news and inflation this morning. But of course, the summary of economic projections, that was revised since March, not since the May meeting. So that's relative to what they thought three months ago. But still, I think it was reasonable to say that, you know, of the officials in March, maybe on average they go up 25 basis points

for the end of the year, not 50. So this would be a hoaxe result in the summary of economic projections. And the problem is that if the Fed doesn't project a September rate cut on average, then it's much harder to implement one. So, you know, of course, you're just playing with small numbers here and decimal points. But overall, the market, which was reacting very well to this morning CPI report, will be somewhat disappointed at the Federal Reserve now sees only one rate cut this year. That said, Michael, I think the market also understands that the Fed is itself kind of a lagging body.

Their meetings started yesterday. We all know they're not going to get the 8.30 CPI report, go into the meeting and say, throw out everything that we did yesterday. We're going to come up with a different decision. and they wouldn't hang anything on a single data point anyway. So perhaps this gyration that we're seeing in response is saying, yes, the Fed still sounds hawkish, but that's because the data prior to the last couple of weeks was much more so

than it's probably going to be now and going forward. Yeah, I think that is true. The employment report was quite strong overall. We're generating jobs $250,000 plus per month. The real economy now casting for Q2 is now up well over 2%. The economy is likely to grow at least 2% this year unless there's a sudden shift in the economy. There's a lot of good things going on.

on in the economy, a lot of sectors of the economy not doing so well, but in aggregate, things are going pretty well. So my view has been, why mess with it? Things are going pretty well. Inflation is still well above target. There's a stickiness to what's left behind for the various reasons we've heard in the past. It's slow to come down. Interest rates are having a less powerful impact on that part of the inflation process.

So let's just sit back and wait for inflation to get better. There's no rush given the real economy performance to do anything. But can you sit back and wait, Michael, when you have a policy? policy rate at five and a half. Now, Steve said this was interesting. They raised their long-term estimate call of what the neutral rate is to 2.8%. But either way, you could say we're two points plus above what neutral should be for an economy. So do we need to still be that restrictive? Well, exactly. The big question they're grappling with is everyone's grappling with is how tight is monetary policy? Where is the neutral rate? How fast can this economy grow medium term?

We're certainly doing a lot better than we were in the pre-COV post-GFC world. And that would suggests that if growth can grow faster, policy rates may have to be higher for longer. We've thought all along that we're not going to see a major rate cutting cycle. We're going to see a mid-cycle adjustment of 50 to 100 basis points, and that's probably it. Kristen, you say that, or you said just a moment ago that we're experiencing in the labor market may be a cooling, not a contraction. Is what the Fed is doing and saying today, consistent with that view, that the economy and the labor market may be cooling? I mean, looking at the statement, I don't think very, very minimal things change within within the statement.

But I think in the press conference, this is going to be important. What data points does Chair Powell actually talk most about? Because, yes, you had non-farm payrolls come in very hot. But when you look at Joltz, when you look at the ISM surveys, right, that we've seen a slowing within the labor backdrop there, there's even some estimates that we could see revisions to non-farm payrolls. And so I think the language and the tone that Terrapal uses in terms of speaking about the employment backdrop, yes, it's strong, but if there's signs of cooling, this can give a little bit more insight. And I think the biggest surprise in this is really the three cuts down to one.

I think that is something that the market was not anticipating. Seeing three to two anticipated three to one, not so much. No, I think that's absolutely a great point. So, David, let me ask you about that. You know, if the market this morning was at two cuts this year after CPI, now the Fed says it's only, it's only at one. How do you think that gap gets rectified? And how might we expect to hear Chair Powell talk about that?

Well, I think one of the things he said in the past is that participants do have the option of updating their forecasts based on incoming data during the meeting. So presumably they did have the option of changing their forecast today based on CPI, but perhaps they were reluctant to do that based on one data point. Overall, you know, we still got plenty of CPI reports to come. To me, the most interesting part of the CPI report this morning was auto insurance finally cracking from this, you know, 22% year-over-year gain that we saw in April to a negative 10th of a percent in May. So if auto insurance continues to back off here, then the measures of inflation will be coming down. I think September may come back onto the table.

But for right now, you know, I think it'll stay off the table in the futures market until the Fed shows some signs of getting a little more. dovish after this sort of tilt towards a somewhat more hawkish outlook. Steve, you have some thoughts? Well, I think what looks to be happening now, I mean, is the market looks to be ignoring this statement and these projections, and I'm not sure the market's wrong here about that. I think the market is processing the data in a way that's different from the Federal Reserve. The market, I think, showing a steadier hand in its take on the data. The Fed kind of, I think it feels to me like this is a statement that you would write

in reaction to the inflation numbers we got in January, February, and March, and it seems to ignore what happened in April and May, which seemed to me to put us back on the tack and the track we were on at the end of last year, which was further progress on inflation. If you have further progress on inflation, why would you so drastically change? And not just the hawks on the committee, but almost everybody lifts it up, gets rid of rate cuts. I think what David is saying is rather smart, the idea that, hey, the Fed may not see it now, but they might yet be cutting in September if the data continue the way it's been going. All right, Steve, thank you very much, and thanks to our panelists for now. We're going to end the conversation here and move forward.

Yeah, let's see how more of how the market's reacting. In fact, Bob Bassani is over at the New York Stock Exchange, Bob. Kelly, this is a negative for stocks, but a mild negative. So the base case was relatively few changes in the economic policy, and that's what we saw. They did, the prior statement did cite a lack of progress on inflation. That has been changed to now. There's been modest further progress on inflation. So a mild upgrade on the battle. But the real problem here is the dot plot. We were expecting two rates, cuts. Now we only have one. And four people said no cuts. That's a little bit of a surprise. So that's a bit of a negative. So let me address Steve's issue here about why isn't the market down more. Look at the conditions right now.

We have disinflation, clear trend right now. We have rising earnings. We have a shiny new tech paradigm in artificial intelligence, and we're a couple years out of a recession. I think that's enough to support the economy. A lot of people talk about 1995 in the parallels. The Fed started cutting rates in 1995. They had a shiny new thing. It was the internet at that time. They had rising earnings here. So there are some parallels here to that that are being used right now. The problem is this Fed pivot, because if the Fed indicates they're going to pivot sooner rather than later, that's a sign that they're clearly winning the war on inflation, and we don't quite have that. So that's what the problem is.

And if there is a downside to this, I would say that right now, I think it's probably going to prevent more money from coming into the market. Maybe that's a good thing. We're at new highs right now. But I think that's the clear downside. But as you can see from the very modest decline here, when you have disinflation, rising earnings, a big shiny new tech paradigm in the form of artificial intelligence, and a couple years out of a recession still growing, that's enough to support the market, guys. And it is for now. Bob, thanks. We appreciate it, Bob Hassani.

All right, let's go to Chicago for reaction from the bond market and Rick Santelli. Hi, Rick. Hi, Tyler. Indeed. Modest progress is what everybody seems to be hanging their hat on. And as you look at a two-year, that was right around 268. Yes, we've moved up a couple of basis points. Then open the chart up to Jobs Friday.

You can see it's holding right and coming into that zone. Look at a 10-year. Ten-year was right around 4 and a quarter, so it's up about three basis points. look at where it's at based on Friday's jobs report. And finally, the dollar index, subtle improvement. And once again, you could see where it's based on the big moves from Friday's jobs report. You know, if you look at what's going on with the Fed, let's be frank here. Okay, we get a cut or two.

How much does that really change? We have a two-speed economy. We have those who have a need for credit and those who don't. And those who don't most likely have savings. Maybe they're baby boomers. Their income isn't going to suffer much with a cut or two. Is it going to help the housing market dramatically a cut or two, especially considering how elastic the relationship is with 10-year yields?

I don't think it will. And in terms of financial conditions, when I talk to people and you say financial conditions, what's the first thing they talk about? The stock market. And where are stock market prices? We all know where they're at. I think you'd have a hard time saying financial conditions are too tight. I think a rate cut or two isn't going to make a huge difference.

And the issue is inflation, the year-over-year number today is still higher, and it wasn't January. It was 3.1. So ultimately, inflation's coming down. But it isn't going to change the middle class's problem, which is the compounding of inflation over the last handful of years. And those prices aren't going down. And even if they stop here like auto insurance, do you really think it's going to go dramatically lower in the future? I don't. Kelly, back to you.

I know. I don't think many of us are expecting a break. Rick, thank you very much, Rick Santelli. We're moments away from Chair Powell's press conference. We'll take you there live as soon as it happens, about 17 minutes from now. But first we'll take a quick break with the Dow down slightly, and the NASDAQ still up more than 1.5% and near record levels. Don't go anywhere. Welcome back to Power Lunch. The Fed decision is in their holding rate steady, and we're less than 15 minutes away from hearing from Fed Chair Powell, which can often be even more market moving. For more reaction, let's get to what investors should do now and to listen for in that. Tim Seymour joins us of Seymour Asset Management.

He's a CNBC contributor. Tim, it's great to have you here. Welcome. And where are you? So the decision was hawkish. The market's not sure if they should react that strongly to it. And where are we now? Yeah, 15 handles down on the S&P off of where, you know, we were very bullish coming into this is impressive given.

The dot plots did not give bulls what they should have wanted. three to one was more aggressive. The crew so far has analyzed this right on. And as you pointed out, maybe a lot more left to go with Powell, who at these pressers really can't help himself but be dovish. And then we'll wait for Fed officials over the next two to three weeks to try to unwind some of that. But the reality here is that the market is balancing it in real time, whereas, as you pointed out earlier, the Fed is certainly a lagging indicator. The story for the market, though, over the last few days has been the continued outperformance of semiconductors. They've outperformed the S&P by 20% since mid-April.

The reemergence of Apple as leadership along with semis, this is a great backdrop for what's working to continue to work. Again, maybe a modest downtick in the economic outlook, but stability and a Fed on hold. This is great for a CAPEX cycle in technology. It's great for companies that are growing. And it really does, I think, give the market some reason to continue to love what it's love since that payroll number, which says the job market's balancing, but it's not falling apart. So I was going to ask you, how do I trade around this decision? How do I trade around the words here?

And I sense your answer from what you just said is do nothing. Sort of stick with what you got if it's working. Well, there are places where I think you've also reaffirmed some trends that may be picking up some more steam. I think consumer discretionary still has headwinds. I think the consumer, and we have this bifurcation, but I think you're starting to see. some low on fumes, even in some of the, call it the higher demographics. I think if you look at some places where you've had interest rate sensitivity, I think the housing market and some of those trades, which are stratospheric again today, and I've been wrong on this for six months. So I just think you have a dynamic here where asset prices there, I think could come under some pressure. But again,

some of the discretionary parts of that housing trade, whether it would be in home furnishings, et cetera, that have been on fire, I would be cautious. I would be buying weakness in gold. I think gold, which gave up a lot of ground on Friday's payroll number, that the dynamics that had you wanting to own gold a week before that payroll number are very much still in play. We have a world and certainly a U.S. where deficit spending is, and essentially budget deficits are a thing of the future. And I think you want to buy some of those dynamics. Interesting, in terms of the bond market, and we've had a massive move, we had a massive move into this.

I think there's a lot of investors, especially in the advisory community, they're looking to see where they can can really push out duration on bonds, where they can be buying mid part of the curve, longer end of the curve. And is this the signal we've finally been waiting? You can look at rates all the way back to July of 2020. And in my view, it's a long trend, but it's still higher.

But we're right at the bottom of that channel in a place where investors, I think, especially those that are looking to make allocation changes, want to own more duration in the bond market. It hasn't made sense to do it until now. Yeah, it's been the anything but bonds bull market as people have called it. And I think your point is interesting,

to mention by the way, the more the Fed can ultimately cut, the more it'll help the deficit. You also, Tim, talk quickly about Apple's leadership and being important for the whole market. I mean, this 11% move in two days is absolutely breathtaking. I think it's shocking on some level when you consider that this is a company that wasn't growing earnings for multiple quarters. But if you think about it's also a company that in terms of its leadership, it hadn't done anything since January of 22. It was underperform the S&P by almost 3% over 615 days. And so this breakout over the last three seems extraordinary, except for the fact that you're talking about now the largest market cap company in the world. That's going to continue to grow software earnings by 8 to 11, 12 percent at a 75 percent margin in a world where they're buying back more stock.

They're going to be cash neutral. In other words, they're going to be giving back as much as they can to get to neutrality. And look, what we also saw from mega cap tech over the last few days around Apple's WWDC is that Apple still owns the consumer. and that you have to go through this distribution channel of 2.2 million, billion, excuse me, devices out there. And I'm not telling you that Apple should run another 20%, but I'm telling you this breakout in Apple was a long time in coming, even if the fundamentals around the earnings profile haven't been that extraordinary.

There's been a lot of other things going on. All right, Tim, thanks very much. And we will see you tonight on fast money at 5 o'clock for more reaction to Chair Powell's comments and so forth. Tim, good as always to see you. being with us today. And we are just moments away from Chair Powell's press conference. We'll get more reaction to that and to the Fed decision when Power Lunch returns right here. We'll be right back. Welcome back to Power Lunch, everybody. We're just minutes away now from Fed Chair Powell's press conference. It should be very revealing, interesting, certainly. We often see big market

moves based on what investors hear or don't hear from Chair Powell during the Q&A. meantime, let's bring in our friend Don Peebles. He's the chairman and CEO of Peoples Corporation. You may remember, if you were watching yesterday, he was the only member of our mock Fed panel to vote for a cut in interest rates. Don, welcome back. Good to have you with us. Explain your reasoning, once again, for those who weren't here with us yesterday, why you thought a cut was appropriate. I thought it was very interesting point of view. And just basically your reaction to what you sense the Fed has done and said here. Well, first of all, the reaction is, no surprise, but growing disappointment. The reason I think they should have reduced rates is what's happening to the banking system right now. If you look at local and regional banks, they have over 80% of the exposure to commercial real estate loans.

Office buildings are in a free fall in major cities around the country, Washington, D.C., New York City, and Chicago and so on. And so those two things are threatening the banking industry, and you add the interest rates to commercial real estate borrowers, has more than doubled in the last two and a half years. It puts such a strong level of stress on these banks, and it also freezes capital where the banks are not able to make loans that they should make to small businesses and individuals, and of course they're calling in and pulling back credit on both of those sectors as well.

So I'm hearing you say, if I'm understanding, correctly, that there is a big day of reckoning coming for small and mid-sized banks because of their exposure to commercial real estate, presumably to some commercial real estate companies. I don't know whether you would include your own in there. I hope not. But that there is a day of reckoning coming and that the Fed is missing it, swinging and missing it. Yes. What I'm saying is that their treatment or their cure is going to kill the patient in some regards. Because, again, There's a big day of reckoning coming. And in fact, the FDIC did a report, issued a report about two weeks ago, indicating that over 600 banks would be insolvent, local and regional banks, if they had to mark their commercial real estate portfolios down to market.

And those properties are not going to recover anytime soon because these high cost of interest rates are strangling businesses in the economy that relies on debt. And then, of course, the consumer is getting hit hard because the cost of housing is doubled because of interest rates and the cost of buy or lease a car has doubled. And so those are big purchases for consumers. And that we're going to see the effect of that. I mean, we've had consumers have $1.8 trillion of COVID relief money. And that stimulus money is now run out. And now we're beginning to see things settling down. And frankly, the rate increases were way too extreme and too rapid to begin with.

So, and also we pointed out earlier that the cost of insuring a car, let alone, apart from the cost of buying a car, has risen by 23% over the past year. It's just gotten really difficult. I am sure there are people, and I ask us with affection and respect, who would say, well, of course Don People's, a real estate guy would like to see interest rates lower. Of course Don People's, a real estate guy would point to a looming crisis that originates in. in commercial real estate and is going to infect the banks with which he may in fact do business. How would you answer those folks? Well, the real estate industry and construction industry is one of the largest employers in most states in the United States and most urban centers

rely heavily on real estate to produce tax revenue, to produce jobs and economic growth and activity and to provide housing to attract more people to come there. And so, So the real estate industry has a major impact on the economy, and of course they have a major impact on local and regional banks because they're one of the largest borrowers. And so we have to look at the industry and its impact on the economy. And by the way, again, automobile industry, housing industry, insurance industries, small businesses. Everyone's affected by these rapid increases in interest.

yesterday, there was one of the panelists spoke about how high interest rates benefit public employee pension systems. Well, most of them have major exposure to commercial real estate and have seen their investments plummet. So they're hit hard by this, too. And so the average worker is going to be affected. Great point. Don, we're going to hear from the Fed chair in about a minute here.

So there are a couple of different things he could choose to do. He could choose to emphasize maybe some of the more recent data, talk about kind of obliquely or directly this morning's CPI number showing that inflation's coming down. Maybe he thinks it'll stay that way. In other words, he could try to shift the emphasis away from the more hawkish tone of the data prior to that to something more forward-looking and say, you know, there are signs that's coming down. I think the market would take that obviously as a positive.

Yeah, and I think that's what he should do. And I think it's likely what he'll do is that we have a soft landing. Things are looking good. The economy has slowed down. And unemployment is stabilized as well. And so, you know, now is the time to begin to look forward and begin to see some reduction. And he may touch on the fact that they can see down the tunnel some interest rate reductions. Although I don't know how exactly, and maybe you could give him the way to message us.

How do you message to the public that you're going to cut rates while they still feel like inflation is too high? Well, I think you have to message it that things are leveling off and we have a soft landing. And so they can look forward and see that things are stabilizing. and will review their policies as they go forward. But I think people want to see interest rates go down.