Power Lunch - The Fed Decision 11/1/23

Episode Date: November 1, 2023

The Federal Reserve held benchmark interest rates steady for a 2nd straight time, amid the backdrop of a growing economy and labor market and inflation that is still well above the central bank’s target. We’ll discuss what it all means for markets, the economy and your money. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome back to our special coverage of the Fed decision. I'm Tyler Matheson, along with Kelly Evans, here in Washington. Just a few minutes away now from the release of the Fed's decision on interest rates, about four minutes to be exact, precise. We'll see what our panel is looking for, but let's get a quick check on the market set up before that. You see, the Dow hanging on to about a two-tenths percent gain. The S&P's up four-tenths, and the NASDAQ is up six-tenths today. The 10-year note right around on the nose at 480. We dipped a little below that this morning after some weaker-than-expected data, especially that weak ISM manufacturing number. It's very forward-looking. It's very market-sensitive.

The ADP employment report was also a little bit light on private sector hiring. That said the Joltz report also showed some strength. So anyway, the 10-year note 480 as we get ready to hear from the Fed. Let's get to our panel. David Kelly of JPMorgan Asset Management, Kristen Bitterly of City Global Wealth, Jim Karen of Morgan Stanley Investment Management. And here back on set with us is Paul McCulley,

former PIMCO chief economist. Welcome to all of you. David Kelly, what's your take? Well, I think the Federal Reserve will change as little as possible in this statement. My version of Fed statement, bingo, is that they upgrade one word with regard to economic strength, and then they just get rid of the clause about how labor markets weakened. But overall, I think they're looking at an economy that is strong, but it's not necessarily hot. I think that's really the important point here.

There's no evidence that inflation is picking up again here. We do think the economy will slow down a bit in the upcoming quarters. So the Fed pauses here, and frankly, I think they're done. I don't think there's any reason to push rates or their luck any higher here. Kristen, why don't we hear from you? I assume you think sort of the same. No move today, but door left open for the future. David says they're done.

What do you think? I would agree with David on this. I think that it's going to be a hawkish pause in terms of leaving some of their optionality open. But at the end of the day, when we look at the overall, economic data that we're receiving. Yes, it's hot, but there's also signs of some cracks and some weakness, the ISM report that we saw earlier this morning. So I think the most interesting part of today is really going to be the press conference and digging into how they're viewing

inflation and how they're viewing kind of the trajectory for longer term rates. Although, Jim, Karen, one of the fascinating things about the last meeting was that the chair was his usual kind of hawkish self. And then the minutes came out and were more dovish. And then the beige book came out was even more dovish. So, you know, I think the Fed is likely not to do anything at this meeting. But I think that they want to leave the door open for the future. So look, I mean, the latest run of data that we've had, and I know it's for the third quarter, but it does give us momentum into the fourth quarter, but the third quarter data was pretty strong.

So it's really a question of, are things cooling fast enough? Will inflation get down to the levels it needs to get to? So if we look at CPI, headline CPI was still printing, you know, a hot 3.7 percent, you know, target core PCE for the Fed is around two. We're still running above those levels. So the question for me is do they use this model, sorry, do they use this meeting today to actually suggest that they may hike rates possibly in December? Now, I don't think that they will, but I think there is a risk that the Fed comes out a bit more hot is just given the recent front of data. Paul, we've got one minute. As the Giants proved last week, a lot can happen in one minute.

Not all of it good. Is this one of those times where doing nothing is actually doing something? Absolutely. Absolutely. We're at 5 and 3-8s for the Fed's fundraink. The entire yield curve is below that level. So the Fed's tight. And if the data is stronger or the inflation is not as disinflationary as they want,

there's room for the marketplace to continue doing the Fed's work. the Fed's in a good place. And so the Fed chief is probably happy that bond yields are higher. Yes, yes. He's quite content with that. He likes the fact that market's not fighting them anymore. All right, folks, we're going to have you all stick around as we get ready now for the decision from the Fed. Widely thought that there will be no change.

Widely thought that, well, the door might be left open. Let's go to Steve. Unchanged, Federal Reserve, leaving the interest rate unchanged at 5. and a quarter to five and a half percent. It's the second meeting in a row. The Fed has been on hold. First time it's done so since early 2022. The Fed, however, is still, quote, determining the extent of additional policy firming, suggesting that there is still a hiking bias in the statement and among the committee members. The committee saying it remains highly attentive to the inflation risk, language precisely from the prior statement, as well as saying that inflation remains elevated.

The economy was upgraded just a bit, saying it's now it grew at a strong pace in the third quarter compared to a solid pace in the previous statement. Job gains were also upgraded just a bit, saying they've moderated instead of slowed in the prior statement. The statement also now mentions tighter financial and credit conditions, adding the word financial, likely will weigh on the economy. That perhaps is a mention for the rise in the 10-year yield and other yields that have, the economy. The decision was unanimous. And now we have a question. By the way, very, very similar statement, only a few words tweaked. Does the upgrade to the economy now perhaps put

additional rate hikes on the table, or is the idea that this statement is so similar to the other one, one that led the Fed to pause? Does it lead you again to think, well, you know what? They're teeing up another pause here. I guess we may have to wait for the press conference to find out. Fascinating. Yeah. Well, there's some of the market reaction. Steve, stick around as we bring our panel back in and Bob Bassani and Rick Santelli also join us. Rick, I'll start with you as it looks like we're seeing yields move lower. Yes, we're moving lower, whether it's two year, whether it's 10 year, from three year all the way out to 30, we have double digit drops and yield. But the real key is why are yields dropping? Now, as we look towards today, obviously

at 830 Eastern, we had a whopping two trillion less in the refunding package of three's, tens, and 30s, and I truly doubt whether that $2 billion less is going to make that much difference. But there was a psychological issue there. And I do think that we have brought in many buyers over the last couple of days with respect to treasuries. They had a failure to launch in tenure with a close above 5%. And now it's a neon sign. Many are moving towards the long end and looking at what they consider juicy yields.

But I think that the Fed has a real problem here. I continue to go back to the notion that we spent $5 trillion during and post-COVID. That money isn't all spent, and it's going to continue to potentially give us a sugar buzz, which makes the Fed's job that much more complicated because we all know sugar buzz growth doesn't lead necessarily to organic growth, which is sustainable. And I'll leave with one final thought that we now have 307 trillion of global debt. Okay, that's per the Institute of International Finance. CNBC did a great write-up about that.

That's as of mid-20203. To me, that's an issue. We can have global slowing, put the U.S. aside. Just look at Germany. Just look at all the global metrics. We are definitely slowing. And with regard to inflation, hey, let's say that it's peak. But one area that's going to remain sticky is going to be electricity and energy,

whether you're in Europe, whether you're in Germany or whether in U.S., that's a lot. transition is always out there. So we're going to have some inflation, lots of energy inflation. We're not going to have disinflation, as Tyler always brings up, bringing us prices back to where they were. And $307 trillion of global debt, to me, it's going to be an issue that continues to keep interest rates mostly higher, even though right now, it seems to me that if we close under four and three quarters and tens any time this week, I think we can go down another 30 or 40 basis points. But in the grand scheme of things, I'm still

looking for much higher rates. All right, let's go to Bob Pisani and see how equities are reacting to this decision by the Fed. Bob. Modest move up in the S&P four or five points here. Not much of a change in the statement. It says job gains have moderated. It said job gains have

slowed in the prior meeting comments. I see here, Fed's still determining the extent of additional policy forming. So a modest hawkish bias. I think the problem for the market now is it's basically positioned in a devious way. It's assuming that rate hikes are essentially done and the Fed's going to start cutting in the middle of next year. So the pain trade that would cause the most difficulty

for the most participants is that all that is wrong, that we are not going to get close enough to the Fed's 2% target goal for them to be enabled to essentially stop raising rates and to start cutting in the middle of next year. And that's sort of the problem the market's got right now. It's potentially wrong here. We did have some good news today on the ISM manufacturing, supportive of generally somewhat weaker economy. So you've got to have that the ability to show that the economy is slowing down here. So I think Powell's probably going to continue to reiterate the economy is resilient. Pricing pressure is still very prevalent. And they're prepared to raise if the evidence does not indicate they are getting closer to their 2% target. That's the risk right now.

I can't help but think he's got to maintain that position that a rate hike is still very much on the table, guys? Jim, you have been the one who probably among this group feels that the Fed may be more aggressive. Is there any, do you agree with what Bob just said, that another rate hike is very much on the table, and maybe this decision and this statement makes it even more so? I think Bob's correct. I'm in his camp here. Look, I mean, the risk in the market is that the Fed continues to hike interest rates. I mean, is it likely that they keep rates higher for longer? Yes.

And yes, bond yields are higher. Yes, the economy is cooling? That kind of misses the point. Is the economy, is inflation falling fast enough? And are they getting to target fast enough? And the question is that it might not be. So all I'm saying is that when we look at probabilities for the Fed funds, you know, rate to move in December, it's, you know, maybe in the low 20 percent probability that it happens.

What I'm saying is that it should be closer to 50%. And I think that the Fed would be happier making the market think that. Now, that wouldn't be good news for equities. That wouldn't be good news for the bond market. But that's part of the solution for the Fed. So yes, financial conditions have gotten tighter, and the Fed stated that. But as Steve Leasman said, there has been an upgrade to the economy. Things are kind of going the wrong way a little bit for the Fed.

I mean, over time, I think that they might be right. But are they willing to risk inflation re-accelerating, becoming unanchored, and then having to come in more aggressively later, or do they want to take out one more insurance rate hike? I'm just saying the odds could be closer to 50-50 for a rate hike in December, and we shouldn't misprice that risk. I think everyone has a different sense, perhaps, Jim, of what insurance is these days, depending on your view of where the economy is in 12 months.

Let's bring Steve Leasman back in as he's been combing through the statement. Steve? I like what Jim said there, that there is definitely the risk out there. there's a certain bias in here that is basically an unchanged bias. They added a little bit on the economy, but they also added a little bit to the downside when it came to financial conditions. I think that the story here is that they noted that their upgrade of the economy had to do with the third quarter.

It wasn't a prospective comment. And so to the extent that Bob Bassani just talked about getting good news, and I don't like using that phrase when it comes to weaker economic data, but it was good news for those who are concerned about the Fed. in the ISM manufacturing, also a step down of the ADP numbers, then that tends to rule out an additional rate hike. So I think we are indeed data dependent here when it comes to what the Fed is going to do next. And if that forecast for a weakening economy is the right one,

which is the one again on the street, then I think we may have a third month of holding here. So, David, let me ask you, is there anything in here? And you heard what Steve just said. Is there anything in here that changes your view that the Fed is done? No, actually, I think it confirms my view. I think two things. One, they didn't have to say that job gains were moderating because frankly, we added

$336,000 payroll jobs in the last print. That's not moderate at all. And so the fact that they said moderating suggests a little dovishness, but much more important, this slight nod to the fact that financial conditions have tightened with those higher interest rates. It's kind of like that's the last additional rate hike they might have done or it's in the place of that. So to me, it says we acknowledge that.

looking backwards, the economy's been strong, labor market's been strong, but we acknowledge that there's even more pressure in the economy coming from these higher rates. They're not willing to claim any progress in inflation yet. I think they'll see some more progress in the months ahead. But overall, this makes me feel more likely. I think it's more likely the Fed is in fact done,

and they won't have an excuse to tighten further. Kristen, is this the hawkish pause you were expecting, or is it a more dovish one? I think the way the market is reacting right now is a little more doveish, but we will see when we get to the press conference. I think ultimately, though, when we're talking about this question of whether there's going to be one more 25 basis point hike, Tara Powell always said it was a question of how fast, how high, and for how long.

And I think the key question is really the how long question. And so what we're going to look to in terms of the press conference is really to any type of signals around how they're viewing inflation. Because when you look at how inflation is breaking down, yes, you may have, it's tough to see that path to 2%. I think you can see a path to two and a half percent, but really when you look at the underlying components, everyone's focused on services. They're focused on owner equivalent rents. When you look at non-shelter services, you're actually within the historical mean. So you're around 2.8%.

All of the other components are actually 2% or below, and you have that owner's equivalent rents with a lag. So there is an argument that the composition of inflation is getting you to a trajectory where you can see a path and you can see a path to that two and a half. not quite at the Fed's target, but certainly something that we want to hear more commentary about. Paul McCulley, bring us across the finish line. I agree with a lot of what's been said here that the Fed did make an acknowledgement that financial conditions have tightened, so that's what we've all been talking about.

They also acknowledge that the economy has been stronger than expected. So you put those two things together, and effectively it says they're on hold. They also still have the bias to another hike. But I'm with David Kelly. They're not going to do it. But the bias itself serves a purpose because it keeps us talking about it. And vigilant. It keeps us from wanting to have a big rally in risk assets.

So I think just the bias itself is useful. It reminds me of 60 years ago when my dad would say, don't make me pull over this car. Essentially, that's what Jay Powell is saying, don't make me pull over this car and do another hike. They did cite that they, so last statement they had cited tighter credit conditions. This time they cited tighter credit and financial conditions. What does that tell you the inclusion of that language? It says that they're getting better transmission of tighter monetary policy.

Remember, they just control the rate, and then it's transmitted to financial conditions, whether it's in the banking system or in the financial markets. So they're getting better transmission. And I think that's hugely important. If you can get the same degree of tightness in the marketplace and the banking system with an unchanged Fed funds rate, then hallelujah. You're getting what you want, which is tighter financial conditions. And the bias keeps the market from wanting to front run the Fed on the Dover side. Steve, maybe this betrays my naivete on this.

But is there any surprise in the fact that there is nowhere in this statement are geopolitics or world conditions or the Israel-Hamas war mentioned whatsoever? Would it be, would have been way out there to have included a reference to it? I think it's not a surprise in that all of my reporting, and I think probably the guests that you've been interviewing as well, Tyler, at the moment have a hard time drawing a line from, the tragedies and the hostilities taking place in the Middle East to the U.S. economy right now. Ukraine has been going on for a long time. That level of violence remains what it's been. What's happening in Israel and Gaza is new, but it hasn't had a market effect on oil prices. So to be completely clinical about awful human dramas, there is not a line.

I did want to mention, Tyler, what's been happening in the Fed Fund's futures market, which is pretty interesting. a very slight bid, now a 33, 34% probability now of that rate hike in March. So what they did is they took their anxiety about January, possible rate hike, and maintaining, this could be just a hedge, but there is something of a bid out there. But more interesting what's happened here is that they took what was sort of a 50% probability of a cut in June, and now they kind of skipped June, they skip July, and now it's September with a cut.

So what's I think happening here is there is a trade-off, and I think Powell is trying to make this trade. He says, you know what, I will trade you that next hike. I don't need to do that. I do need you to think about higher for longer and price that in. And I think that's the trade the market is taking and bidding right now. Rick Santelli, anything you'd add? No, I agree with much of what said, but I think as I look at the markets, here's what I see. I see virtually unchanged on a tenure, maybe a basis point lower on twos,

which means that the Treasury complex pretty much ignored or didn't see anything new to worry about. Equity markets are darn close within 10 points, the Dow Jones. So what I see is that there are many, and I know this was discussed earlier, there's many who the tightening Fed doesn't affect. There's a lot of boomers out there that don't need credit. They don't have a mortgage. They're most likely not going to look for a mortgage. So we can't even get at that crowd.

And I think that all the rest that are affected are going to continue to be consumers that don't necessarily participate. I do think that retail sales is going to start to slow down a bit. And I think some of the metrics for GDP were distorted by inflation. I think the Fed has done a pretty good job

as of late. And I also do agree they're done. And I guess I'm a glutton for punishment, Steve, because I'll bet you another tranche of cheeseburgers that they don't have another hike the cycle. David Kelly, why don't you wrap it up for us here? Are you now persuaded that, well, they are done.

You've said that before, but that higher for longer is the regime? Yeah, I mean, if they follow their normal playbook, they're going to wage too long to cut rates. But that's how it works. So I think, you know, at some stage next year, we might see some economic weakness. We may trip into recession. The economy is going to be growing slowly anyway. But my guess is that when they cut, people are going to say, You waited too long to cut.

Yeah. I remember you saying this two years ago, David. You said what happens here is they wait too long to start. They go too far and keep it there. And they stay too long before they pull away the regime. How do you think? Oh, yeah, David Kelly, Chris and bitterly, Jim Caron. Thank you very much.

And we are minutes away. And Stephen and Rick as well. Minutes away from comments from Fed Chair, J. Powell. We'll get some more analysis after a quick break. Welcome back. The Fed leaving interest rate on change for the second straight time, saying inflation remains elevated and they've got their eyes on it. Let's get some reaction from Dennis Lockhart, former president of the Atlanta Fed. Paul McCulley, former PIMCO chief economist, still with us to participate in our conversation. Mr. Lockhart, welcome. Good to have you with us. What do you think? Well, I've been listening to the commentary up until this moment in this half hour, and I think people have it mostly right. David Kelly thinks they're done. I would put this nuanced spin on it. They're done if conditions allow them to be done,

conditions that we really cannot predict very well for the coming months. But if their current outlook holds, there's a good chance they are done. But they're not done because they've made a decision to be done. I think Powell and company will keep their options open. and in the coming press conference, I doubt you'll see much of a signal about what they'll do in December. We've had Paul this setup before where market is almost unchanged after the statement. Then the press conference begins.

He says something relatively hawkish and off we go for that day or sometimes for the next several weeks. Now, last time was a little bit of a break from that pattern. But point being, what should we be on the lookout for in terms of his remarks when he starts in about 10 minutes? I think a lot of the questioning is going to be on this whole issue is how close are you to sufficiently restrictive? Because that's magic language in fed speak that they want to get to sufficiently restrictive, and then they want to hold there. So it's really a two-pronged sort of issue is, are you sufficiently restrictive? And I think he will fudge on that one. And then the issue is, how long do you plan to stay there?

And I think, you know, as Dennis was saying, is we're going to stay there. until we get evidence that we don't need to be here anymore. So I think essentially he's going to try to encourage the marketplace to hold the back end of the curve up in anticipation that long is long. Mr. Lockhart, why has the economy remained so resilient in the face of what have been very aggressive and steep interest rate hikes? Why hasn't it seemed to slow it down, even though there are signs now that maybe it is in fact slow. Well, I think the basic dynamic is one of consumer spending being held up by good employment

outlook on the part of households. As long as people feel they're going to be employed and they have some income security, the American consumer will consume. And I think when the outlook changes and there's a little bit more to worry about in terms of employment, maybe we'll see a slowdown in spending. But it's being driven by spending. And, And the American household has both perhaps the balance sheet, the savings to continue spending still, as well as a positive outlook in terms of income. And so just to stay on this point, Dennis, for a moment then, do you think that they can convince the markets to stay up here at sufficiently restrictive for a pretty long period of time? Or does it still depend on things like the jobs report Friday morning and how that evolves? You know, in my experience, it's very hard for the committee to shape market outcomes.

I think the committee is more of a mind to simply set policy at the policy stance they think is correct and hope the markets are aligned and hope the markets will help. But the idea that they can say something in a press conference or in a speech or in a speech or in a statement that actually produces an outcome in terms of bond pricing in the markets, I just don't think they have confidence they can reliably do that on an ongoing basis. Paul, if you could ask President Lockhart one question, and now's your chance. I might even give you a second question. It's a good question.

What would you ask them? Do you talk right to him? Talk right to him. There he is. I would follow up on the comment that he just made when that. The committee itself can't manage forward expectations on Wall Street very well. I would certainly agree with that. But my question is, can the chairman do that?

Can the chairman do that? I think the chairman can certainly have a big influence. The chairman speaks for the committee. When the chairman speaks, it's entirely different than, for example, when the presidents speak. But at the same time, we live in a world in which, markets are influenced by all kinds of things that may not be anticipated in what the chairman has to say. So I think there is a limit to how much confidence the chairman and the committee have in trying to actually produce a market response or market outcome.

How soon, Dennis, do you think it will be before we get to that 2% inflation threshold that the Fed keeps talking about? Well, I've noticed in the least of September SEPs that the committee appears to be pretty patient and that it's in the out year that they get close to the 2% target. So I don't think it's anytime soon and I am prepared to believe that the last mile, as it's called, is in fact going to be difficult. One of your earlier commentators spoke about getting to 2.5% but getting from two and a half to reliably around 2% could be a really long pull. So far, I think the committee is prepared to be patient and not over-tighten in order to get there sooner.

Interesting. All right. Dennis Lockhart, thank you very much. We appreciate your time. As always, it's great to see you. Paul, you're going to stick around. You've behaved yourself very nicely. You get to stick around until the chairman comes on. We're just a couple minutes away from that event.

Chair Jay Powell's press conference begins half past the hour. We'll take you there as soon as it begins. More of our special on the Fed decision after a break. Welcome back as we await Fed, Chair Powell. Let's get some final thoughts from Paul McCulley before we let you go. I just want to mention that we haven't really talked about QT yet, and not that that's a big part of the statement or anything, but he might get some questions about it in the press conference

and the extent to which them shrinking the balance sheet is contributing to higher interest rates. I'm pretty sure he's going to get some questions about that at the press conference, and appropriately so. QT's running in the background. They've said that many, many times. But essentially, QT leads the Treasury to have to issue more duration to the marketplace. And everyone's been wrapped around the axle about the deficits and the auctions and all of that sort of thing. And essentially, QT operates in the same direction as a larger deficit. In fact, the Treasury's got a fund not just to the deficit, but effectively the bonds that the Fed is not rolling over, which leads to an increase in the term premium, which we're all focused on now.

So I think QT is going to come back into the arena as an important topic of discussion. I really do. You know, and I just, I guess I'm trying to figure, what would be the most elegant way for them to achieve their monetary policy goals at this point, doing more of it, doing less of it, more interest rate hikes, fewer hikes, trying to get the curve. the balance sheet? I don't think they should be moving it around a whole lot. I think having it not on automatic palette, but in the background is important. But actually, I think they're doing a good job with it now, because given the fact the marketplace has got this notion, we need to have a positive term premium in the curve, and that is

tightening financial conditions. Then QT actually contributes to that in giving you a higher term premium. which means that an unchanged policy rate can give you tighter financial conditions. And QT is contributing to that. So the Fed doesn't have to brute force up financial condition tightness with the policy rate that QT can do some of the work along with the marketplace. Absolutely, absolutely.