Bond market had a ‘wake up call’ from Fed decision: Wells Fargo Sr. Macro Strategist

Yahoo Finance’s Julie Hyman, Myles Udland, and Brian Sozzi speak with Mike Shumacher, Wells Fargo Macro Strategist, about the Fed decision and outlook for the economy.

Video Transcript

MYLES UDLAND: Mike Shumacher joins us now, senior macro strategist over at Wells Fargo. And Mike, you have your note right at the top. Two dots equals double trouble for the Fed. How did you kind of read that plot when it came out? And how did you guys think through the implications of, I think, a larger than expected change in that forecast from the FOMC?

MIKE SHUMACHER: Yeah, it was surprising, Myles. There's not much question about that. I think a lot of people in the markets thought either the Fed would stand pat or maybe tack on one rate hike. But two I think caught most people off guard.

And from our perspective there were a number of interesting takeaways. I'd say first and foremost, the Fed revised up dramatically its inflation expectations for 2021. So that tells us the Fed is still guessing, like all of us, in terms of just how long this inflation surge is going to last.

But the other thing that's interesting to us is that if you go to the out years, 2022 and also '23, there was very little change in the Fed's inflation projection. So it's pretty interesting to see the number of rate hikes go up from zero to two, while the inflation forecast basically is static. That's kind of a tough disconnect to get around.

And the press conference, frankly, didn't learn a lot from that. I think Chairman Powell is trying to preserve maximum flexibility. A lot of speculation on when the taper talks actually accelerate, when tapering certainly begins. But for us, it really was two rate hikes, and also the inflation switch.

JULIE HYMAN: So Mike, what explains the disconnect to you between the change to the rate expectations at the same time that the inflation projections are not changing? Is it sort of a nod to the market in a way? Is it sort of tacit acknowledgment that maybe it's not transitory, or maybe it's going to be more persistent? Or the transitoryness might last a little bit longer, but still be transitory? What do you think?

MIKE SHUMACHER: Yeah, it's interesting, Julie. I suspect the biggest thing to focus on here with respect to why you've got this disconnect is it really is a committee. And when you consider the dots out in 2023, they're just all over the place. So it tells us there's a very wide range of views.

And it also, I think, tells us the confidence level in inflation forecasting is pretty low. So it indicates perhaps a number of people on the FOMC are saying, well, look, inflation's up a lot more than we expected over the last few months. Maybe this continues longer than we expect. Therefore, it seems pretty sensible to say, why don't we put a rate hike or two in the picture out 18 or 24 months.

So I really think it is this very diverse committee. Lots of different views about the inflation picture that's showing up in the rate hikes.

BRIAN SOZZI: Mike, what happens to the bond market moving forward after what we heard from the Fed yesterday?

MIKE SHUMACHER: Yeah, the bond market really got a pretty big wake up call. And when you think about other central banks out there, there's been a fair amount of talk about maybe not tightening, but at least becoming less accommodative.

But for the Fed to go down that path is challenging. And quite a few investors we talked to had been of the mind or the view that rates would stay quite low for a long time. Maybe yields would go up over the next six months, but pretty gradually.

So they were pretty comfortable implementing strategies to try and pick up a little more return, a little more yield, the so-called carry strategies. That becomes a lot less comfortable today after hearing the Fed.

MYLES UDLAND: Yeah, Mike, something else we talked about earlier on in the program was, you know, what the conditions would be in 2023 that would justify the Fed raising rates. I'm curious, based on the economic projections that were offered, it seems like the Fed believes there's a scenario in which it's a 2015, right? Where you've got an economy that's performing about as well as the Fed would like, and they want to normalize rates. But there might also be in play a scenario where it's inflation that is encouraging the Fed to raise interest rates. How do you come down on the question of what would actually trigger the Fed to do those two rate hikes, which now seem on the table in a couple of years?

MIKE SHUMACHER: Yeah, Myles, it's probably a balancing act. And as Chairman Powell keeps pointing out, yes, employment's half of our mandate. So we'll focus on that. We'll focus on inflation. It's really a function of how the Fed weighs those things out, call it 12 months.

And at this point, the Fed is not telling us really how that scale works. So if unemployment continues to fall-- and it's come down dramatically over the last six months-- that's a big positive. But if inflation remains high, then the Fed's got some thinking to do. I suspect in the ideal world, the Fed would love to see unemployment get down to 4%, perhaps a bit lower. But the inflation picture may not give it that opportunity. And that's why we're still bearish, frankly, at Wells Fargo.

JULIE HYMAN: Mike, something that always amuses me about all of this exercise is that like they don't know what's going to happen in 2023. Nobody knows what's going to happen in 2023.

Like maybe you have some visibility in the next 12 months, but given, for example, what the jobs report has shown over the past couple of months, I would quibble with the fact that we even have visibility for the next 12 months.

So you know, I don't know. I don't know what my question is linked to all of this. I guess I'll come back to you guys being bearish and why you're bearish, and what kind of vis-- what do you know? What do you feel like you know with certainty right now?

MIKE SHUMACHER: I think a couple of things there, Julie. First of all, to your semi question, the economic data that's super tough to forecast for everybody. And that tells me there's just so much uncertainty out there. I mean, look, we get a pandemic once a century. So no one's got that baked into some sort of econometric model. You just don't know. And it means we all need a dose of humility.

So in terms of what we're pretty comfortable with out, let's say, 12 months, or perhaps longer, we do think inflation's going to surge up as it has been, come down, but probably still remain higher than it had been back in 2017, 2018, that time frame.

And also, when you think about this enormous amount of stimulus that's in economies globally, that's having a huge impact in really trying to get this recovery going pretty quickly. So you're going to see growth numbers that are off the charts for a lot of countries. And that, we think, puts a lot of froth into markets, labor markets really in particular.

So what we know down the road is that the central bankers get less comfortable with that sort of thing. Maybe they don't get back to anything like we saw in 2017 or '18. But it seems to us that tacking on a few rate hikes here and there, whether it's by the Fed or other central banks, is pretty prudent. And we think it's pretty likely.

So looking forward 12, 18, 24 months, those forecasts get a lot more comfortable. Month to month, really no one knows. You can't tell what the next payrolls report is going to be, plus or minus a couple hundred thousand, or the next inflation print, plus or minus a few tenths.

MYLES UDLAND: And Mike, quickly before we let you go, Jackson Hole tends to be a big moment for Fed watchers. Feel to you like that is building to another event where we could get that signal on tapering, as was almost sort of suggested yesterday?

MIKE SHUMACHER: It's possible, Myles. It seems a little bit too soon to us.

And the reason I say that is that there is still so much yet to be learned about the labor market. I just said it would strengthen. I'll stand by that. But I think we'll have a better picture in terms of how that works when all these supplemental unemployment benefits go away, and also when kids go back to school. So I figure that's September time frame. So we get those data points in October.

So Jackson Hole, maybe. Yeah, a big stage, a lot of attention. But it seems like it's probably a couple months early to us.

MYLES UDLAND: All right, Mike Shumacher, senior macro strategist over at Wells Fargo. Mike, appreciate the time. I know we'll be in touch.