Power Lunch - The Fed’s Path Forward: Prepare For A Pause? 3/22/23

Episode Date: March 22, 2023

The Federal Reserve just hiked interest rates by a quarter point, and indicated increases are nearing an end. We’ll discuss where we go from here, and what it means for markets, the economy & your money leading up to 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.

All right, welcome, everybody, to a special edition of Power Lunch alongside Kelly Evans. I'm Tyler Mathis. I'm glad you could join us on this historic day. Just a few minutes now from the biggest Fed decision on interest rates in some years. That's right. Before we get to our panel of experts, let's get a quick check on the markets, the pre-fed setup. We're off the lows, but we're also off the highs. The Dow's down 69 points.

The S&P, look at that. It's right on the nose at $4,000 down two points. And the NASDAQ is up 15. David Kelly is Chief Global Strategist at JPMorgan Asset Management. Nixon is CIO at Northern Trust Wealth Management. John Bellows, portfolio manager at Western Assets. Let's whip around quickly and get each of your anticipations for this event. John Bellows, you go first. So we think today is about financial stability. You know, we're still in the middle of

significant concerns about stability in the U.S. banking system. The Fed has a role to play as the primary regulator, and we expect Jerome Powell will make a forceful case for the Fed acting aggressively and responsibly to stem the banking concerns. And so I think today's about financial stability. That's where we expect the headlines. And I think Powell will be forceful in the Fed's defense of financial stability. And on interest rates, where do you think they come down quickly? You know, I think they hike, I think they hike 25, but again, I don't think it matters. I think today's about financial stability. That's where he's going to make headlines. That's what's important. There's the one stake in the ground. Katie Nixon, where do you stand?

So I'll say maybe a more balanced statement that confirms the awareness of the need to focus on financial stability, but also reinforces the fact that you can't have financial stability without price stability. So we do expect a doveish hike, 25 basis points, accompanied by a balanced statement that really recommits the Fed to fighting inflation, but also acknowledges that the downside risks have heightened given the instability in some of the financial sectors. All right. Mr. Kelly, you get to bring us across the finish line here. What are you expecting? What do you think we'll hear? Well, they're going to have to do a lot of changes to the statement here for once. So I think we get 25 basis points.

I think they will acknowledge some further progress against inflation. I think they'll say something positive about that. I think they will remove the presumption of any further increases. They'll talk about future changes in the federal funds rate, but not future increases in the federal funds rate. I think they will talk about that they're keeping their eye closely on financial stability and in the banking system. And finally, I think they will say that they will do whatever it takes and they're confident. they have the resources to maintain the stability of the financial system. So they've got a lot to get it to communicate today.

And it's going to be a very interesting few hours here. Although, David, I think your line here kind of summarizes the way a lot of people feel when you say, I think they will raise by a quarter point, but you feel that would be a mistake and they should pause. Yeah, I think we've had monetary whiplash. And the problem is that hiking rates in this way is not a very good way of slowing the economy. And I think they've just overdone it. They were too low for too long, and now they've been too aggressive and raising rates,

and that's why we've got this instability, frankly. I remember, David, your wisdom about a year or so ago, when the Fed moves, they move too late, they go too fast, they stay there too long. That seems to be what you think has played out. Yes, but the question is, you know, having got this high, how long can they keep it there? And the futures market is saying that if they raise rates today, they're going to have to cut twice before the end of the year. So I think that's going to be an interesting tension, Mark.

Katie, one more thought from you in terms of what you expect them to say, vis-a-vis future rate hikes or changes in interest rates. 30 seconds, please. I think they're going to keep their options open, honestly. I think it's going to be a very, very carefully worded, carefully constructed statement. To David's point, leaving all doors open to either no more rate hikes to rate cuts, I think they want to leave a lot of flexibility here, given the fact that there's so much uncertainty. All right.

Well, we will see in about 20 seconds what the story actually is. Let the record show that John Bellow says today's statement is going to be largely about banking stability, more than about monetary policy, but we're certainly going to hear about that and inflation in just a few seconds time. Steve Leesman is waiting for the top of the hour, as are we, and it is here right now. Steve. The Federal Reserve raising by one quarter point by 25 bases points to a new range of 475 to 5 percent, It is the ninth hike in a row since the Fed began hiking in May 2022. The Fed providing some guidance saying additional policy firming may be appropriate.

That's perhaps a bit of a downgrade for what they said last time, where they said ongoing increases in the policy rate may be appropriate. Now they're saying additional firming. We'll have to talk what that means. Now, they said recent developments, which seems like a youth from is perhaps for the recent turmoil in the bank market. They said recent developments are likely to result in tighter credit conditions for households and businesses. Those tighter credit conditions will weigh on economic activity, hiring, and inflation. The extent of these effects, however, is uncertain.

Now, they left unchanged their year-end projection for the funds rate at 5.13%, which suggests they believe they'll be hiking at least one more quarter point and then be done. They raise next year's funds rate projection to 4.3%, which you'll notice is below the projection for the year-end. So there are some cuts built in by the Fed next year, but a little bit. bit less than there had been before. They forecast a bit more inflation this year at 3-6 versus 35 for the core PCE. They said inflation remains elevated. Remember last time they said it in eased somewhat that was gone from this particular statement. They said the U.S. bank system remains sound and resilient. On the economy, modest growth in spending and production, and production

they've noted, job games have picked up and running at a robust pace. Guys, the one thing I'll notice from this thing is first the change in language for some additional firming may be appropriate. The other thing is almost no connection at all from their comments about the impact of tighter credit to the effects on the economy with policy, except for that little squishy language about what happens next. Kelly? All right. Steve, thank you. Stick around. We have the markets shooting higher in response to this. But as we know, we get the kind of post-2 p.m. reaction, and then we get the Fed press conference reaction. Then we get the Fed press conference reaction. the closing bell reaction, and then we get the rest of the week. And by the way, Powell doesn't have a

great track record for risk assets in that regard. But right now, the complex looks positive. The NASDAQ is up half of a percent. The Dow is up about 26 points. A similar move for the S&P 500 as well. Let's bring back our panel, Bob Bassani, Rick Santelli, watching the market action for us. Rick, let's start with you. What do you see in the tens, twos, and everywhere else? Two's and tens dropped rather dramatically. Two's, especially dramatically. We dropped to 393 and then it popped up to over 4%. On the 10-year note, I saw the market get very close to kind of 340-8, 349 area before it popped just a bit. The dollar index did the same thing. It dropped a bit. So what are we looking at in macro simple terms? We're looking at interest rates moving

lower across the curve. We're looking at equities, and I'm sure Bob will get to that in a minute, not looking too badly. Everybody, of course, is monitoring what's going to happen with the next set of Fed meetings that happens in May. Are they going to do a quarter point or not? That's how it's turned so quickly, but there's nothing surprising here. Every trader I talked to was looking for 25. A few were actually looking for 50. Every trader I talked to thought stocks would be the better of it and that all markets that they monitored from interest rates to the currency markets with respect to outside the dollar, all these markets were going to rally, and they have been correct. And I will go on record thinking that the press conference is not going to take this

away. I think the press conference, if anything, is going to accelerate these moves. Bob, what do you make of it? We've seen a seesaw where stocks dip lower, and now they're kind of trying to claw into these gains. Where's your attention focus? Well, there were two options here, assuming that a 25 basis point hike was what happened, and that is what happened. So the Fed could either pause and specifically explicitly signal that they're pausing, or they could hike and simply say the economic conditions are a little uncertain. And it seems to be the latter one. And I don't think that's necessarily a bad thing. So this phrase, additional policy firming may be appropriate.

Well, okay, they're saying maybe we'll hike in the future. but that's a much, much weaker version of their prior statements, a much weaker way of saying that we might rise. So that's certainly a bit bullish. And then the failure to really acknowledge the banking crisis is kind of striking. They said recent developments are likely to result in tighter credit conditions, but the effects are uncertain. That's a nod, but it's a pretty weak nod.

So the implications here is that they are dealing with the crisis. They're still not entirely sure what the outcome is here. So I would say that this is a pause, but a very, very weak form of the pause just enough to make the markets satisfied. The real worry for the market was what happens if they explicitly said, we're sorry, the banking crisis, we have the tools to deal with this, and we are not done fighting inflation, and we are not necessarily going to stop our interest rate hikes. That would have been a major problem. That's not what happened here, and that's why I think we're getting this modest rally right now. David, what do you hear in the statement as we look at the famous octobox? That is my favorite thing.

Eight people in one box. It is a thing of beauty. What do you make of the statement as we covet the octobox? And the fact that their prediction of core PCE or inflation is up from what it was, not down? Well, on the inflation number, I'm not surprised by that because our own models were saying that, you know, inflation's coming down. it just has to come down steadily. And in fact, they were quite optimistic in December on the pace of decline of inflation.

So I'm not surprised I had to mark that up a bit. But it's still coming down. It's coming down very steadily. And I just think that I think they're having a problem pivoting here. They really should have pivoted to a much more neutral stance. I think this is, you know, clinging onto some hoaxiness, which they're not going to be able to cling onto for very long. But it is a little bit more hoaxish than I thought,

but talking about further firming rather than further changes in rates. And also they didn't acknowledge any further. the progress on inflation, even though the year-over-year inflation rate is now fallen for eight consecutive months, and wage growth is running well below inflation. They could have acknowledged that. But unless they say they're making progress against inflation, then it's getting harder and harder for them to pivot without sounding like they're scared of the banking system. So I think they missed an opportunity to go to a more neutral stance here. Katie, do you agree? Well, our view was that they were going to raise 25 with another 25 to come and that they would

strike this balanced state, which I think they didn't. I think it's really interesting the focus on credit and not financial stability as being sort of the transmission mechanism of what's gone on in the last few weeks. And as we all know, credit was getting tighter before we had this recent bout of volatility. So I think the Fed is clearly focused on the direct transmission mechanism of this period of instability on growth and inflation. And again, keeping their options open. And I don't think they had the ability, really, to raise a red flag on financial instability without undermining the confidence that has sort of slowly started to come back into the markets. So they had to strike the balance, and I think they did.

And we should add, as we watch the market's reaction, Dow's up about almost 100 points. So similar to where we were pre-meeting. David Bellows, just want to go to you on this and this idea that kind of the Fed has to do with the market has priced in or that they like to kind of leave people with the sense of where they're going and then fulfill that. And as a result, everything's hunky-dory. You know, they did that for basically every meeting of the past 12 months. And yet the rate hikes still broke stuff. So I don't think we need to be myopic here and looking at the reaction this half hour to a macro effect that's still

going to play out for the next year, year and a half for quite some time. You know, Kelly, I think that's exactly right. There's a lot of uncertainty about the outlook right now. you know, the, what is the impact of all the rate hikes that have happened? You know, that's broadly the story that's going on in the banking system, is they're being impacted by those higher rates. For sure, that won't be the last thing that's impacted. And the Fed, I think, is rightly kind of citing the uncertainty about how exactly that plays out. So I think you're on the right point regarding the uncertainty. You know, I certainly heard in the statement the Fed doing more to acknowledge that uncertainty than they have in the past. There may be more firming and, you know,

it's uncertain what the effects are. And I think that's realistic. So I think the Fed you know, is realistic in citing the uncertainty there. You know, I just want to come back to this idea of financial stability. I think that line that Steve just read about the banking system is safe. I think that's a new addition to the statement. You know, I could be corrected there. And I think that's a theme we're going to hear a lot more about it. I think the market over the last few weeks has been trading primarily on this financial stability question.

You know, it's not so much about the inflation outlook. It's about financial stability. And so, you know, I think that's a new addition to the statement. I think that's what we're going to hear about in the press conference. that's what matters for the market right now. They need to restore confidence in the financial system in order to pursue all these other objectives on inflation and unemployment.

But the order of business today is really on financial stability. I think, Steve, you would agree that the U.S. banking system is sound and resilient. Those were not words that necessarily would have been in previous statements, but we know why things have changed, and so the statement needed to reflect that. As you go through the words here,

what stood out to you, if anything? Well, two things. One is this use of the language of firming. Maybe David Kelly will tell me if I'm wrong, but there's a couple ways that policy confirm. Policy would firm if, for example, the policy rate remains the same and the inflation rate fell. So there is an interpretation here that I think we're probably going to ask Chair Powell about, which is, did you go to the word firming because that means you may not want to raise rates? For example, if tighter financial conditions, restrictions restrict lending and cause the economy to slow down and bring inflation down, then and the policy rate remains unchanged, the Fed would not actually have to increase some more.

And I will tell you right now, I'll give you a fresh quote here. The probability of that May hike is now 62% or 64% of there another quarter. That is built in. But we'll hear how Powell explains what he means by firming and why that's different from ongoing rate increases. I suspect it's because the inflation rate could decline. is, I feel like Powell's trying to have it a little bit both ways. I don't know that he's getting away with it here, but he's saying, look, we need to, inflation is elevated, we need to fight it, we're raising rates. But we have this huge thing coming down the pike year of tighter financial

conditions, which are going to do a whole lot of bad things to the economy. It's right there in the statement. So it just strikes me that if all those things in the first paragraph were true, then things about policy in the second paragraph ought to have been a little more doveish. Rick Santelli, Chair Powell, would not be the first politician or office holder to want to have things a little bit both ways. No, that's certainly for sure. And this Fed, especially I think, should be looking to have it both ways because they've really screwed this up in more than two ways, waiting too long to hike than hiking too aggressively. Listen, I'll tell you what, there's a little bit of tone deafness to this entire conversation.

Because I don't know. Does anybody here really look at these banking issues is something standalone? These are just more negative feedback loops to the tightening cycle. I mean, let's oversimplify this, whether it's inflation, bank stresses, illiquidity, mounting unrealized losses through accounting issues, geopolitics, inverted yield curves. All these are under review. And not even the big picture is included in that. Think about all the supply chains that have reconfigured. The fact that they're going to be more inflationary has something to consider as well. We didn't see big pops when China reopened, mainly because there's a lot of question marks all over China. I just think there's so many issues for the Fed to talk about.

Debating firmness seems to get lost in that conversation in my world. I think the issue is everybody knows the Fed should stop here. Whether they do or they don't, that's the haven't both ways. by almost diminishing the fact that they have caused the cracks that we are now witnessing. And I certainly don't think that this calm is going to just disappear. These issues are here, and they're going to remain here until the market gets used to this new aroma in the room

called rate normalization. And yet they still, David Kelly, have the terminal rate at 5.1%. Yes, and to Steve's point, you know, I think maybe when they changed it from additional increases to firming, the nice thing about firming is firming could mean one increase or it could mean two increases or could mean three increases. If you don't do that, you have interest rate increases. You either have to say interest rate increase or increases. So that allows them to get away from the

singular plural issue with regard to further rate hike. So maybe that's what they did. Because as you said, they still got this 5.1% at the end of the year. And the market does not believe that. And I don't really believe that either because we've got a lot of, you know, what we're seeing here is we've had tighter lending conditions before all this happened. I can. can't believe that after the last three weeks, that banks are going to be more willing to lend or small businesses are going to look like a better proposition to loan officers than they did a few weeks ago. So I think you're going to have a lot of economic tightness as this year goes on. And by the way, also, oil prices have come down, inflation expectations have come down.

So, you know, people have said the Fed is between a rock and a hard place. I think the Fed is between a rock and a soft place. Because we've got softer inflation, we've got softer economic growth. They should just stop and not try to micromanage its economy. I mean, really overshoot on rates. I need to have to cut them next year. That's exactly what Rick just said. Katie, let me turn to you. David quibbles with the idea that the terminal rate may be 5.1%.

He doesn't think it's going to get that high. Do you? We do, actually, at this point. It might not get that high in May. There might be an opportunity here for the Fed to skip a meeting and assess the data as well as the cumulative impacts of all the rate hikes that they've put in place so far. But until and unless we really see inflation start, to fall in earnest, consistently, much faster towards the Fed's target.

I don't think they can really get away with pausing. And I think that Powell, probably at the presser, will take the opportunity to take a page out of Christine Lagarde's book by striking that separation between the financial instability issue and the inflation issue and making sure that we all recognize that you can't have one without the other and that they have separate tools, separate tool kits to address each. So I think the Fed has to remain really committed on this inflation issue, and that's going to keep them a bias towards tightening policy and hiking rates. And yet, John, the yield curve is back to 50 basis points. So this is the two as tens anyway.

And would you describe that as kind of the sequence that usually plays out once we're already kind of heading into that macro slowdown event? Or do you think this is a bullish signal either for stocks or for the economy? Well, a quick point on this word, firming. You know, Steve points out that one way policy confirm is an unchanged policy rate in falling inflation. Another way policy confirm is if the policy rate remains unchanged relative to the market expectations for a cut. And so in that case, you know, the Fed will be delivering tighter policy than is discounted in the markets right now. And that could be considered affirming as well. You know, I think the broad point here is there's a lot of uncertainty about the outlook.

I think the Fed's acknowledging that. And, you know, it's really hard to know exactly how that's going to play out over the next few meetings. I guess my final observation here is I think the yield curve is telling us that, you know, going forward, you know, a few meetings, even a few quarters, you know, there is a disinflationary process underway. You know, that's likely to be accelerated by the tighter financial conditions from the credit crunch. It's a matter of time before that, you know, is really apparent and kind of taking hold and the Fed acknowledges it. But I think that's what the yield curve's telling us is that disinflationary process is underway. It's a matter of time. And that's why yields are lower in the future.

at least price in markets. All right, Dow's down 10 points right now. S&P is still positive. We'll leave it right there. We know the real drama is often, at least for the markets in the press conference. Thank you all so much for your time today. We appreciate it. And we'll hear from Chair Powell himself at 2.30. Just about 13 minutes from now, we'll take you there live as soon as it begins. But first, we'll bring back former Atlanta Fed President, Dennis Lockhart, to break down what's at stake. His response to the statement, what does firmness mean? There's more Fed coverage ahead when power lunch returns. Welcome back to Power Lunch, everybody. The Fed raising interest rates by a quarter of a percentage point, expressing caution about the recent banking crisis and indicating that hikes are nearing an end. As we await Fed Chairman Powell's press conference, let's bring back Dennis Lockhart, former president of the Atlanta Fed for his reaction to the Fed decision. As you kind of predicted, the vote was unanimous here.

Yeah, at least the consensus that came out of this meeting was quite tight. I think it's interesting. just seem to look at the dot plots and I have to compare them to the December dots, but it looks to me like a very tight consensus near term, but 24 and 25, you're beginning to see some divergence, so different views over the medium term of what could develop. Sure. And I think that reflects, you know, the fact that the macro has gotten more uncertain. Dennis, so is this the right move or are they going to look back and go, why do we hike rates after we were having a bunch of banking crises when the leading indicators were rolling over and it was obvious that we were heading into a downturn. Time will tell, Kelly. I think, you know, this was very much a judgment call. And as I said earlier,

I think it could have gone either way. And there are very good cases or there were very good cases for either a hike of 25 basis points or a pause. So we'll see how things play out. You talk the lot with your panel just before the bottom of the hour about the word firming. Right. You know, my sense of that is they felt they had to be less explicit given the uncertainty that we're facing. This is probably a big message that will come through in Powell's press conference, uncertainty, uncertainty, uncertainty.

And they just didn't feel they could go forward with. the same language they had last meeting that was quite explicit. They're likely to be more rate hikes. So they just toned that down a bit, made it a bit more ambiguous to buy them some flexibility. Is this an environment where investors should want to own stocks? Should they try to gobble up whatever yield they can right now on treasuries and other kinds of short-term, you know, high-yielding securities? What would you do?

You have all these experts that are market experts, which I'm not on the program. So that's a good question to ask them. My personal belief is that we should have long-term faith in the U.S. economy and therefore owning some stocks, it makes sense. And depending on how you want to use the yield, it's not a bad time to capture what is probably pretty close to some peak rates. but I'm not an expert. I'm going to beg off on that question. The statement from the FOMC was appropriately, mostly about

economic conditions and interest rates and glancingly about stability of the banking system. But my sense is, my gamble would be that at 2.30, we're going to hear many more questions about stability in the banking system and the Fed's reaction to Silicon Valley Bank

and others than we did in the statement. I wonder what you think quote, went wrong and quote, with respect to Silicon Valley Bank and the others that are sort of in extremists right now. And was it a failure of regulation and supervision? Was it a failure of bankers making rookie mistakes? Was it some of each, some of a lot of things? Probably the sum of a lot of things. We have an investigation underway by the Fed that will look at the supervision of the San Francisco Fed. And I think when we get a decent history of all this, there will be a lot of people to point fingers at. Having said all that, I think that supervision

needs to think deeply about whether we understand the speed and severity of a run in an age in which communication is all digital. We have social media and you can transact in a matter of seconds. And the reading I've done over the last few days at that point comes through clearly that it's not your grandfather's bank run any longer. It's a bank run that can occur in a matter of seconds, literally. And that I think may change the playbook going forward. Yeah, it wasn't people showing up at the doors of SVB with pass books saying, get my money out. This was all being done. Mr. Lockhart, always a pleasure to see you. Thank you for your time today. Thanks so much, Tyler.

Great to have you with us. We're just moments away from Fed Chair Jerome Powell's press conference. He will likely be asked what does firmness mean. Many questions about bank supervision. We expect to see big market swings. The Dow's down four points right now. Power lunch is back in two. Welcome back as we await Fed Chair Powell's press conference. Let's get some final thoughts on a market check. We bring in Michael Santoli. All right, Mike, so Dow's up 10 or so. It's kind of been back and forth.

Some people say, hey, this was a non-event. You know, we're back to where we started. What do you think? I would say it's an event. It's a largely as expected event. But I think the market reaction, at least initially, is an acknowledgement that the difference between a pause and leaving open the possibility of a hike down the road

or a hike today and then becoming data dependent and more flexible as they did. Not tremendous, not a huge difference in the market had priced it okay. I would imagine Chair Powell might not want to make much news in the next hour. He may not succeed in that effort, but it would seem to me he wouldn't want the market to just race ahead and say the Fed is done, Fed is our friend again. And they also wouldn't want the reaction that said, uh-oh, policy mistake. They're overt tightening. They're kind of insufficiently attentive to the financial stability risk.

So to me, how he characterizes the level of alarm about banking stability might be the thing to look for. Right. What would you be watching, Mike, as the press conference begins? And then in kind of the days to come as this thing shakes out. Well, it's interesting. The market has in this little uptrend. We were at 3,800 in the S&P at the low a week ago Monday. That was down 6 or 7 percent from the couple days before SVB went down.

So we had our little pullback. We've had our comeback. And now it's about kind of equal footing that we're on right now. I do think he might get pressed about the dot plot. I don't think the dot plot is terribly important, but there's some inconsistencies there, right? They're saying, oh, unemployment might be a little bit lower than we anticipated, but it's much higher than it is right now. And yet still, we might be hiking and inflation is coming in a little hotter than we thought. But still, we're just talking about being data dependent.

I think this is the way you get that muddled message near the end or transition point. of a tightening cycle that's transitioning to something else. Is that what this feels like to you, that we are coming close to the end of this tightening cycle? Yeah, I think there's a general sense that what the Fed really does is get rates up as fast as possible, as fast as the market allows it to the general zone that feels right for where we are,

and then wait to see if there's some kind of adverse reaction. We got one, and, you know, there's some elegance to doing an exact 12-month tightening cycle. The upper end of the range now is 5%. maybe you can soon declare some sort of victory on that.