Power Lunch - The Fed Decision 9/20/23

Episode Date: September 20, 2023

The Federal Reserve stayed put on Wednesday, but forecast it will raise interest rates one more time this year. The fed funds rate remained unchanged in a targeted range between 5.25%-5.5% Wednesday, taking it to the highest level since 2006. 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 to a special Fed decision power launch from Washington, D.C. I'm Tyler Matheson. Kelly Evans right here with me in Washington. Just a few minutes away now from the release of the Fed's decision on interest rates, top of the hour. And we'll see what our panel is predicting. But first, let's check on the markets and where they stand. As you can see, the Dow is about three-fifths of a percentage point higher. The S&P higher by about a fifth of a percentage point, but NASDAQ roughly flat. The 10-year note yield at 4.319. Let's get to our panel. BC contributor Stephanie Link of Hightower, John Bellows of Western Asset Management, David Kelly of JPMorgan Asset Management, and Greg Ip of the Wall Street Journal. Welcome to all of you. Stephanie, let me begin with you. How close is this Fed to being done raising interest rates? And could this be it? Yeah, I've been saying for a while that we're in the ninth inning in terms of this rate cycle hike. And I still believe that to be the case. So whether they go, probably not today, whether they go in November or not, I think we're We're close to the end.

That being said, Tyler, the economy continues to have a lot of momentum. We're seeing above-trend GDP growth, led by the consumer, led by pockets of manufacturing, and that's leading to continued persistent inflation. We've made progress. We went from 9.1% CPI to 3.7 in a year's time, but it's not close to where the Fed wants to go.

And we know that core PCE number is really what they pay attention to. At 4.2%, it's still much too high. So rates stay higher for longer, and that's what we have to live with. John Bellows, do you buy that argument? Rate stay higher for longer, but the Fed stays where it is right now. We're near the end of the cycle. You know, I actually think we're a little bit closer than what Stephanie just said.

If you look at the inflation numbers, for instance, you know, on the three-month basis, they're actually much better than the one-year basis. And what that signals is that the more recent progress on inflation has been substantial. I think similarly for growth. You know, we've had a good growth year, but more recently, what we started to see is some cracks in that. Housing starts this week was notable for having a big turn. So I think we're much closer in terms of inflation being closer to target.

I think we're closer in terms of seeing some slower growth. As a consequence, I don't think the Fed needs to make much change today. I think you can read interest rates unchanged and leave their forecasts unchanged because a lot of progress has been made. That is proceeding carefully today. Greg, what are you watching? So, you know, in the old days when I started covering the Fed, in the statement they had something that was called the bias or the balance of risks.

And essentially what this was saying was even though we may not have changed rates today, what we're telling you was where we think the likelihood is of moving in the future. And that was in essence talking about whether they were more worried about inflation being a problem, more worried about unemployment being a problem. And essentially for the last few years, the balance of risk has been to tighten further, that all else equal, it was more likely that they would go again, that they would not go. In the last few weeks, I think, starting with Chair Powell's speech at Jackson Hole,

we've seen the needle suddenly move back towards not quite but almost to a neutral balance of risks. And I think that what I'm especially looking forward to the press conference for us to hear whether he ratifies the view that rather than being in the position of we're going to raise rates unless the data says otherwise, I'm looking for a comment that effectively says we're going to keep rates where they are unless the data says otherwise. David Kelly, let's get a quick, quick, 22nd thought from you. You expect the Fed to sound hawkish, but maybe active. a little more doveish. Yeah, I don't expect them to raise rates today, but I think you'll see one dot still say, or the dots will still say one more hike this year. So I think the messaging will still be cautiously hawkish. I do think they should be done. I think they probably are

done because I do see some softening in the economy here. That's very interesting. So you think they are done, but they will sound, leave open the possibility of a move up later in the recent. We are ready now to go for the Fed decision in Steve Leasman. The Federal Reserve maintaining its interest rate at five and a quarter to five and a half percent. But the committee continues trying to determine the, quote, extent of additional policy firming that may be appropriate. So there's this bias in the statement suggesting they're still looking to raise, race.

And indeed, the average Fed forecast does continue to look for one more hike this year with an average forecast of 5.6%. Importantly, and I'll come back to that, there are two fewer cuts, 25 base point cuts built in for next year, on the economy. Economic growth was upgraded to solid from moderate. Job growth was said to have slowed, but remains strong. Inflation remains elevated, and the committee repeated its commitment to a 2% inflation target. The average forecast, let's get to the forecast for next year, now sees a 5.1% funds rate next year. That's up from 4.6. So there's the higher for longer we've been talking about

all morning here. And just so if you want to do the math with their inflation rate, it's now only a half point of cuts built in compared to a full percentage point next year. The real rate actually goes higher next year. So the Fed, average Fed forecast sees itself getting tighter relative to the inflation rate, which remains the same at two and a half. So they have a real rate of 2.6 next year versus 2.3 this year. The funds rate is above neutral, by the way, all the way into 2026. It's our first look at 2026. They have a 2.9% funds rate versus their neutral rate of 2.5%. The Fed more than doubled the GDP forecast for this year to 2.1 from 1% of the prior forecast to 1.5% next year from 1.1%. Lowered the unemployment rate for the next several

years by about 3 tenths, so it doesn't see as much unemployment as it previously forecast. And it continues to mention the banking system, but not do very much with it. It says tighter conditions, credit conditions for households could weigh on economic activity, but the extent is uncertain, and it's all unanimous, guys. All right. Thank you very much, Steve. Stick around. And we bring back our panel. And we're also joined by Bob Pazani and Rick Santelli. Let me turn to you, Bob. What is the market reaction here seconds after the Fed releases its report? Well, here's the effects of higher for longer and a little more hawkish here. So yields up. I see S&P just turned negative. We were up modestly on the day here. And I think everybody wants some confirmation. Core inflation is turning lower. But what you see here is, is more hawkish comments on the economy. Economy is growing stronger than they thought. So the GDP revised, it was 1%.

The estimate, now it's 2.1%. Unemployment was 4.1, now 3.8. So the economy is growing stronger than they thought. That's a little more aggressive. And we're seeing yields spiking up here. I think the fourth quarter is going to be very, very hard to read. Everybody was asking me today about what are they going to say about? oil's been up, yields have been up,

dollars been up, resumption of student loan debt. That's what people are talking about down here. So it's going to be very hard to figure out how to call what's going to happen in the fourth quarter because people are expecting the economy to slow down, but you sure didn't see it here from the comments from the Fed overall, guys. All right, let's go out to Rick Santelli.

Rick, what's your spin? Well, it certainly looks to me like higher for longer, I would sort of modify a bit. say holding here for longer. And that really describes it. And I think the reason they need to hold here for longer is because like many of us, including the market, sensing some very sticky inflation out there.

And I disagree a bit that this is hawkish. Okay, I understand that you had 12 officials at see what, one more rate hike, seven that sees us on hold. But I also see headlines here that job gains slowed. If there was one thing to say that would be meaningful coming from the Fed, it would be job gain slowed. And if you follow non-farm payrolls or you follow the unemployment rate, it certainly seems as though that is the case. And when it comes to the markets, look at what the two-year note yield has done. It chopped

back up to 514. Look at what tens have done, back to 436. Why is this important? Many were taking solace in the fact that rates were down a bit today. I don't at all look at it that way. I look at it that the market's been tight, it's been orderly, and it's been rising. And yesterday, as I said, on many refrains and courses today, new cycle high yield closes, twos, twos, threes, fives, tens, even sevens, except for sevens don't go all the way to 07 because they weren't around in 07. So we want to continue to see what the markets are saying. And why are the markets out of phase with the Fed now?

When prior to this, when they were starting to run, raise rates and Fed funds were more into threes and four percent area. Market rates were moving down because they really thought inflation would mostly vanish. But the stickiness of certain pockets of inflation. And you could say X, food and energy, but those pockets are glaring and they bring a lot of eyeballs to the Federal Reserve. You could strip it out, but you can't ignore it. Greg, let me ask you a little bit about the politics, the politics of the Fed here, in other words. So what they're saying about next year is very hawkish, right? They've said only one or two cuts instead of three to four.

Their median rate forecast is now 5.1 instead of 4.6%. How much of this is what David Wessel just said, which is that they're afraid of letting the market get too far ahead of itself and getting excited about rate cuts, but do you think they're actually still going to do as many rate cuts as they previously thought was likely? You really have to heavily discount any projection for what they're going to do more than a few months from here. They actually have no idea what they're going to do. I would say that part of this, I'm going to guess, might have been internal Fed politics. There's a handful of members out there who have been talking about, yeah, they'd like to go one more time because they don't want to take any chances. And maybe the way you mollify them and get the unanimous vote that the picture of Powell got today is saying, we're not going to raise rates now, but we're going to tell people that we're not going to cut them as much.

Now, when I look at the projections, you see an economy, and this is how he reconciles the very strong growth, very strong labor market that doesn't seem to be responding to the tightening they have to date. He says, okay, we think the economy's going to be stronger than we think. We think unemployment's going to be lower than we think. All else equal, that creates more upward pressure on inflation. How do we respond? We extend the period of monetary restraint for longer. This is essentially the tradeoff. We don't need to go higher, but we need to keep our foot at least depressed on the break for long.

to keep the economy from running ahead of its potential. If we zero in on the last three months, though, we're talking about an economy with 2.4% core PCE inflation, adding about 100 and some thousand jobs a month. I mean, that feels to me like a very different picture than the one from three or six months ago that they might still be responding to. You can tell two stories about the economy.

You could look at the unemployment rate going up, as many of us do, and tell us that's an economy that's starting to grow below potential, where you can look at the GDP numbers, which are, what, 3% or plus for the current quarter, well above potential? And by the way, we'll get new revisions on Friday, and maybe the story will look very different. But I think that if you're the Fed, what you say is even if the inflation numbers are doing what they're supposed to do,

they're coming towards 2%, all of our models, all of our muscle memory says that good news on inflation cannot endure if the economy continues to run ahead of capacity. And therefore, we are not going to take a chance on that. And so, well, we don't feel like we have to raise them now and push the economy into recession. but this is an economy that given the head of steam and the resistance thus far to tightening in train says we need to basically maintain again the degree of restraint for longer than folks thought. And by the way, I think Wall Street might have been slow about this, but the bond market, we've seen 10-year yields moving up for some time. I think in some sense that was dis-sadowing what the Fed just told us today.

Stephanie, Link, let me turn to you. Does this feel to you like a Fed that is close to done with this cycle? Yeah, I do. I mean, first and foremost, I'm glad that they paused, not a surprise. They have risen rates 11 times, and plus they're doing QT. And they're going to continue to do QT, which doesn't get enough press in my opinion. So now we wait and we see, and we're now all data dependent. And the dates to keep in mind are on October 11th is a PPI number. And October 12th is a CPI number. Of course, we get the jobs number on the six. So we're all going to wait to see on that regard. I also thought it was interesting that they They did revise GDP higher, and it's because we are doing better as an economy, much better than what most people expected. A lot of people at the beginning of the year, Tyler, expected us to be in a recession by now, and we're far from it with the Atlanta Fed tracker at 4-9. That number's going to come down.

I know it, but at least we're above trend. And then finally, again, a reiteration of the 2% inflation target. He said it a lot at Jackson Hole, and they're recommitting to it again, and they're not going to come off that 2% inflation target. we have a ways to go in terms of core PCE. David Kelly, were these the hawkish sounds that you expected to hear out of the Fed? Yes, they are. But I think we should be careful about this forecast.

I completely agree with Greg. They don't know what they're going to do with rates next year. And what I'd say is this is not so much a soft landing forecast. It's really a soft landing scenario. If we have a soft landing, then they will only cut rates twice next year. And I think that is a reasonable forecast. But, you know, I take very seriously the drags that are gathering here, student loan repayments. I think that higher energy prices, higher gasoline prices drag on the U.S. economy.

I think the UAW strike is troublesome. I think the possibility of government shutdown is troublesome. I think the effect of higher interest rates is on the banking system, on lending. All of these things are building pressure on the economy. So even though the third quarter is going to look spectacular in terms of GDP growth, it's going to slow sequentially after that. And I think the Fed is not out of the woods in terms of having a recession in 2024, even though this forecast would suggest no recession in 2024. Greg, you want to jump in?

Yeah, there's one point I want to make is that we're going to hear from Powell soon when the press conference begins. And as you and I have talked about it in the past, he will often sometimes push in the opposite direction of the sentiment that you get from the statement and the projections right. What I'm going to listen for very carefully is how does he talk about those out-year projections for the federal funds rate? When Chair Powell really wants to drive a point home and he thinks that the SEP, the projections are helping him that, he will align himself. He'll cite the projections. When he actually wants to subtract from that, he'll often say, well, that's just, that's not necessarily a promise. It's just a bunch of people putting numbers down. So does he align himself with that more hawkish out-year forecast or does he play it down?

That's what I'm looking for. John Bellows, jump in here. Your reaction to what's just taking place? You know, a lot of our conversation has been about growth, and it does seem like the Fed has responded primarily to the better than expected growth. But I wouldn't want to over extrapolate the good growth that we've had. You know, a lot of that has been for kind of very pandemic or post-pandemic specific reasons. There's been a fiscal impulse on top of that. But those aren't things that you can extrapolate forward.

So as you try and put your forward thinking on, you know, I do think you need to take into account the lags of monetary policy, the restraint from restricted monetary policy. And so I wouldn't want to over extrapolate growth. And so when I look at this forecast both for growth and for interest rates, I'm a little bit concerned they're over extrapolating on the good growth we've had. And if growth slows, which, you know, I think there's a reasonable chance that it will. I think the outcome could be quite different than what they've written down. Steve? I am just a little afraid people might be missing a story here.

I think the way to think about the Fed is in the context of the real rate and what they're forecasting. and that real rate shows that they are tightening next year. I think this is a recipe for the Fed to be blowing, the possibility of a soft landing. Greg is right. They don't know what they're going to do. They don't know what the economic outcomes are going to be. David Kelly could be right in the sense that a lot of these things gathering up

could create softness. But the interesting thing to me is the intention of the board at this point to maintain such a high rate while they did not change their inflation outlook. So they are looking at a real rate that is more, restrictive next year than it is this year. I don't know if that speaks to their lack of confidence in their ability to bring down inflation or what that speaks to. We may have a chance to ask Chair Powell about that. But the idea of the real rate going up and not going down even a little bit like it was previously forecast, to me, is worrisome and something that needs to be watched

by markets. The real rate being the difference between what their expected rate of the federal funds will be next year versus the inflation number. Right. Exactly. versus core inflation. And that, not because they expect inflation to go down very much, but it's because they expect rates to stay high, right? They do expect inflation to go down, and they're not lowering rates as much. And I'm curious to know what's behind that, but there is certainly in the forecast, a turn-torchalkishness in those forecasts for the outlook for next year. Very interesting. Very interesting. All right. Thanks to our panel, everybody. We appreciate it. Appreciate your time. And we are, of course, of course,

moments away from hearing from Fed Chair Jay Powell himself, and we'll get some more reaction to the decision from former Fed Vice Chair Richard Claretta after a short break. We'll be right. Welcome back to everybody. The Fed holding interest rates steady as expected, but pointing to rates staying a little bit higher for longer. As we await Fed Chair Powell's news conference. Let's get some reaction from Richard Clarita, former Fed Vice Chairman and Global Economic

Advisor at Pimco. Greg, up for the Wall Street Journal. Still with us. Thank you for staying around. Richard, welcome. Good to have you with us. You were looking for a so-called hawkish hold. Is that what we have here? That's certainly what we have here. I expected them probably to take out one hike from next year. They took out two hikes. They didn't really change the inflation outlook that month.

And also, they really do have a soft landing here. They have the unemployment rate peaking right at their estimate of maximum employment. And so this is a Fed that sees a soft landing, but it wants to buy some insurance against that with, I think, a pretty hawkish pause right here. Steve Leasman pointed out one thing that he, I expect, is going to ask the chair about, and that is the idea that real interest rates, the difference between the rate and the inflation rate, is actually going to rise next year. What would you say the message is in that? I think the message is that this is a committee that is probably happy with where they are and where they're projecting, but they do not want to repeat the mistakes of the past of premature mission accomplished, as we saw in the 60s and 70s. And so I think the balance here is reducing rates less rapidly than inflation to keep stance in a relative restrictive zone with what is a very, very hot and healthy labor market and growth projection on the market. other side. How much of a complicating factor is the fiscal spending that our Congress reporter,

Emily Wilkins, just highlighted, you know, just today they're dispersing another 200 plus million dollars from the Chips Act? Well, that's right. And I think our expert team here does think that the Chips Act and the other legislation will be introduced to the economy over time. So it's not necessarily a big impact in 24. But of course, let's be honest, fiscal policy has been a big surprise. We've had a big increase in the deficit this year. There's still some accumulated saving from past programs. So fiscal policy, I think to the Fed, it is a wild card here, and I think they do need to factor that in. Talk to us a little bit about employment and jobs and what they said today about what the numbers seem to indicate for 2024 and beyond. That's really what I took note of.

you know, the traditional view, and I'll confess I have been in that camp, is that some of the adjustment to disinflate and get inflation down reliably to target is going to require some softening in the labor market, not a great extent, but some softening. Until today, that was the Fed's view. They had the unemployment rate rising about a point to four and a half. In today's projections, the unemployment rate goes up, I think, to four one. That's a very great outcome, But that really is a soft landing disinflation. And that is, you know, that's a change from what their thinking has been. I want to come back to a point that Steve made and actually get Rich's feedback on this.

But the fact that, hey, Rich, how's it going? But the Fed now seeing the real rate somewhat higher over the medium term. In 2025, you have the federal funds rate near 4%, even though you have inflation more or less back to the 2% target. and you have the economy growing at trend and the unemployment rate and the long-term natural rate, right? So given all that, I almost want to say that 3.9 to 4% funds rate

is their view of the long-run funds rate. That's what it should be. But if you look in the same document, they say that their view of the long-run funds rate is still only two and a half where it's been for years. And by the way, that number is starting to look really stale. If you look at the long-dated forward curve on the market,

It thinks that the neutral rate is more like three to three and a half. So I'd like Rich's view on what he thinks is going on here. If the committee is a little bit behind the times in terms of thinking where the neutral rate is, because this has huge implications about where long-term yields are, discount rates are, everything in the financial markets. Well, and Greg, it has implications for the basic question. Is policy restrictive? It's only restrictive if it's above some estimate of neutral. So you're absolutely right.

I would suspect, we'll find out in a couple of minutes. I would suspect that if the chair is pressed on that, we may hear him, as we move further into the future to 2025 and 2026, probably downplay the dots in a precise way. We could be surprised. Maybe the message today is, as you suggest, you know, my own thinking is at least at the front end of the curve. When the Fed succeeds in getting inflation down to two, then the short-term funds rate consistent with those objectives is going to be more or less what we saw before. But obviously, we have to get there first. And part of, I think, what we're seeing both from the Fed and markets is a bit of, you know, I'm from Missouri, you have to show me. And I think that's part of the risk management calculation here as well.

Although, of course, I mean, it either implies they need to be cutting rates by another point and a half to bring it to what they think is neutral or that they're going to be running it very restrictive or like you said, Greg, that they're behind the times. Rich, do you yourself kind of have a view on what's going on with long-term interest rates and which side of this trade you'd be on? Well, yes. I mean, so I think what we need to do is distinguish between the very front end of the curve, the federal funds rate, and the longer end of the curve, say a 10-year treasury bond.

You know, historically, there was a positive term premium in the yield curve. Investors got a higher yield and return by taking on interest rate risk. That term premium was essentially squeezed out of markets in the prior decade. And certainly my thinking is looking ahead, especially given all the government debt that's been issued in the last dozen years is that we will see a higher term premium and possibly a steeper yield curve. And the way that balances out between the long and the front end, you know, we'll find out. But that's the way it looks to me right now. Does this all spell soft landing to you, Rich?

Well, it's certainly a fad that thinks that the baseline is a soft landing. I continue to be in the camp that thinks we're going to probably need to see some additional softening in the labor market beyond what they're showing. But look, this has been a very surprising cycle, the pandemic, the reopening, the recovery, the surge in inflation, and now the rapid disinflation. So I guess the real lesson to take from the last three years is, you know, be prepared to be surprised. What are the fourth quarter potholes that you have your eye on, Rich? Well, you know, the economy has gotten a lot of support from the ability of households to draw down that $2.5 trillion of excess saving, again, in the aggregate, you know, we had a period

where a real disposable income was contracting for about a year and a half, but households kept spending. So I do think that, you know, the ability to keep on chugging along in some sense is more limited than we saw. Also, look, oil prices are a wild card. It's sort of, we've been focused on so many other things in the last several months. We've had a big move up in oil on supply decisions. You know, the U.S. economy is different from in the past. It's less exposed to higher oil prices. But again, high oil prices push up headline inflation,

and that's obviously a wild card as well. Rich, thank you so much, as always. It's great to see you. Richard Claredo. Thank you. And I don't know whether, Greg, whether you're staying or you're going. You're welcome to stay as long as you want.

He's staying, I'm told. You better stick around her. You're talking to each other. I don't think that could be straight. We're just about six minutes away from hearing from the Fed chair himself. Jay Powell's press conference begins at 2.30. We'll take you their live as soon as it starts. There's more of our CNBC special, the Fed decision, after the break.

As we wait for Fed Chair Powell, let's get some final thoughts from Greg Gipp of the Wall Street Journal. I'm just going to go ahead and pick up where we just left off. We're in Washington after all, Greg. And how much are structurally higher deficits in debt, potentially a part of why people think interest rates might be higher than they used to be? I think they're a very big factor. I mean, very basic economics. I'm sorry, modern monetary theory, but basic economics says, if you want the public to hold twice as much government in debt as before, you're going to have to pay them. And so we should not be shocked that real rates are reflecting that.

I think it's notable that the latest run-up in real rates began with the announcement of the Treasury quarterly refunding, which was much larger than people expected. Is it a disaster? Does it mean 8% inflation interest rates? Does it mean we're going to be Mexico? No, no, no, none of that. But the idea that long-term interest rates will be 2.5% that the real short-term interest rate will be 0 to 0.5, as it was 5 years ago, I don't think that comports with the reality of where we're going with inflation and with government deficits. Which may explain why the 10-year, not that it wasn't before, but it's very sensitive to headlines out of Japan, for instance, or developments there. I mean, any market that has a lot of government debt already, it seems like that's really moving the needle for investors right now. Right. And Stephanie mentioned we're underplaying QT, and I agree with her.

that, like, for a lot of the last 10 years, who are the biggest buyers of government bonds? The Fed. Central banks. Not only that they're not buying now, they're selling, okay? So in addition to all the new supply coming out of governments, we have all that other stuff rolling off the central bank balance sheets. That is a lot of debt for the private sector to absorb. And that means higher interest rates. Because you've got to pay them more. That's how the market clears. That's how the market goes. You have to pay more.

You sound like you're from the Tea Party, Greg. I mean, this is the argument for shutting down the government, I guess. I am not making a judgment one way or the other, you know. We borrow money because we have certain priorities, whether it's the safety net, whether it's worn in Ukraine or whatever. But you can't deny the arithmetic economic reality that if we're going to be structurally borrowing more in the future, then that all else equal means real rates have to be higher. Even in a recession, I mean, some people say it's not going to be different this time. Supply never drives things in the long run.

They will come down in a recession. But will we hit the zero lower bound, which is a fancy economist's way of saying zero interest rate, and stay there for seven years again? I really doubt it. Yeah. I think that was a generational matter. I really do. I think it was a once-in-a-generation.

I think it was a post-financial crisis matter. Yes, yes. Remember, like the Kenneth Rogoff, Carmen Reinhardt, work, all about debts. They always told us that we've been through these crises before, and they take seven years to basically work their way through. Well, it's been actually about 10, 12 years, right? So a lot of the low rates that we went through in the pre-pendemic period were really just working through all the de-leveraging post-crisis.

It's all gone now. We've got a few seconds. What are you going to be listening to from Powell? I think the thing I'm going to be looking for is where does he put the inflection on where he is with respect to risks? We know that inflation number is a bit better than the last time he spoke. The growth number is a bit stronger the way he spoke. Which does he worry about more? My gut sense is that he's going to basically ratify the view that unless the numbers go in a very adverse direction, they're done.