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The Fed is ‘chasing the market’ and not ‘leading the market’: economist

Aneta Markowska, Jefferies chief financial economist, joins Yahoo Finance to discuss the outlook on the economy in the year ahead, the treasury market, and interest rates.

Video Transcript

JULIE HYMAN: First, we are going to turn to that rates question because it is a very important one for the market. Let's bring in Aneta Markowska. She's Jefferies chief financial economist. And Aneta, you, like everybody, you're watching those rates very carefully as we are seeing them go higher that seemed to have been problematic for stocks, perhaps over concerns about inflation or reflecting concern about inflation and tightening financial conditions. First of all, how high do you think the 10-year yield is going to get? And why don't you think it will be problematic for financial conditions?

ANETA MARKOWSKA: So I think by the end of the year, we're likely to get close to 2%. Having said that, I would look for a little bit more stability, at least in the near term. This whole repricing of rates started with the Georgia election. It was about the market internalizing the new fiscal outlook and what it means for the economy and ultimately for the Fed policy. And we're there. We fully internalized it.

When you look at what the rates market is sort of discounting as far as the Fed outlook, it's actually discounting a pretty aggressive scenario at the time, at the moment. So I think we were there. I'd be surprised if we really start to push through 160 in the near term. Again, over time, absolutely as we kind of compress the distance to liftoff through sheer passage of time. But right here in March, 160 seems very aggressive to me. So it seems like we should be stabilizing just below that.

As far as the impact on the economy, I really don't think whether the 10-year's at 120, 150, or 2%, it doesn't matter this year. What are the major growth drivers this year? It's the reopening of the service sector, which is completely rate-insensitive. It's all about the vaccine. And fiscal policy, which in the near term is also not going to be rate-sensitive.

So again, I think the economy is going to plow through it, maybe with some exceptions like housing. But on the whole, I think this is going to be robust growth. And again, that's what the market's been internalizing over the last two months. And I think we're there.

MYLES UDLAND: Aneta, we're just over a week away from getting the latest dot plot from the Fed. And as you know, the Fed conversation tends to focus probably too much on when the next rate hike is. It's sort of hammers and nails, right? It's the conversation everyone wants to have.

I'm assuming you don't see any change in the Fed's forecast for short-term rates. But what might they be looking to do maybe by December of this year, when we start to get 2024 forecasts coming into focus and we can really see the other side of this?

ANETA MARKOWSKA: So I do think that at some point this year, and maybe not quite this meeting but by June, that you're going to see the median 2023 dot lift off. As of December, I think there were five participants that had a lift off in 2023. I think you could see a few more move up this meeting but probably not the median. But yeah, absolutely, by the end of the year, I think that will become the Fed's base case, 2023 lift off.

And frankly, that's the right thing to do, just given that I think we're going to be at full employment by the middle of next year. The question is, what's already priced in? And the market's already priced for several hikes in 2023 and some good probability that they might lift off in 2022. I think that's actually too aggressive.

So yes, those Fed forecasts will be kind of pulling forward lift off. But my point earlier was that the market is already there. So this is really a case of the Fed sort of chasing the market and not leading the market. I was really concerned about this meeting a month ago because of these revisions and what they might do to the rates market. But the market has already fully, I think, priced that in.

BRIAN SOZZI: Aneta, I read your work as soon as it arrives in my inbox. And one reason, among many, I do is because you're tracking the economy in real time. I know you track very closely restaurant openings. Right now, what does your real time tracking tell you about how fast the US economy will grow this year, in large part because of this new stimulus plan we just got?

ANETA MARKOWSKA: So yeah, our real time economic activity index inflected on January 15. So it actually did a pretty good job telling us that retail sales for January were going to be strong, and payrolls were going to be strong. We did have a little bit of a setback two weeks ago as a result of those winter storms that hit Texas and the Midwest. But we've sort of resumed the increase last week.

And I think we're on track, actually, for pretty strong growth. I'm expecting 9 and 1/2 percent GDP in the first quarter, north of 8% in the second quarter, and growth averaging almost 7% this year. But importantly, it's going to be front-loaded, right? So that, again, goes back to the Fed keeps telling us this is all going to happen in the second half of the year. No, it's already happening. And that's why the market has had to reprice this so early on.

So yeah, I think the economy is in a great shape. We're going to see the data continue to surprise on the upside, probably for the next three, four months. What retail sales for January really showed us is that there's tremendous propensity to spend the stimulus checks. You literally saw card spending data inflect the day those checks hit bank accounts. So presumably, the next front will hit, I'm guessing, in the next two weeks or so. And you're going to see probably another leg up in retail activity, if not in March then certainly by April.

BRIAN SOZZI: So Aneta, you're calling for-- I mean, those are some big numbers, GDP growth of over 9% and 8% really in the first half of this year. What does inflation do, given those growth estimates?

ANETA MARKOWSKA: Yeah, so I think we might see some spikes in inflation this spring as a result of inventories in the retail sector being very, very low. But I would agree with the Fed that this is all transitory. This is a function of sort of a temporary supply/demand imbalance. There is no reason why businesses can't add capacity, right?

Labor is still cheap. Capital is very cheap and very easily accessible. So as long as you have low funding costs for expansion, as long as you can have access to relatively inexpensive labor, there is, again, no reason why businesses can't add to capacity. So I do expect, ultimately, all the inventory shortages and bottlenecks that we're seeing today, I think they'll be resolved in the second half of the year.

We might see a similar kind of phenomenon in the service sector in the second half of the year. But again, I think small businesses have sort of demonstrated a lot of resiliency. And I think you're going to see a lot of them come back. So to me, the real inflation pressures kick in when you run out of labor, right? And so I think we'll get there eventually. But that's more of a story for late 2022 and into '23.

JULIE HYMAN: I also have a question about the second half of the year, Aneta, when it comes to the type of spending. You talk about the growth being sort of front-loaded in the year. And there's this thought that the second half of the year, we'll see a migration away from as much tech spending, as much spending on goods and toward services. Is one better than the other in terms of overall economic growth?

ANETA MARKOWSKA: I'm not sure better is the right word. But I mean, service output is generally much more labor-intensive. So as far as the impact on the labor market and the speed with which we get to full employment, I mean, certainly, the reopening of the service sector is going to be very positive for that.

I also think that we are going to see, within capex, a rotation a little bit away from technology, which has obviously done very, very well over the past 12 months, but into industrial capex. And I'm actually expecting one of the biggest industrial capex cycles that we've seen in many years. And that's a result of-- we're literally sitting on record low inventories right now across the economy, whether it's housing, whether it's retail, whether it's manufacturing. And I think that bodes very well for industrial capex, particularly in the context of a lot of companies being cash-rich, having access to still cheap capital.

So that's sort of the part of the economy that hasn't really participated in robust growth in quite some time. So I think that's very encouraging. And by adding all this new capacity to the manufacturing sector in the US, that can certainly bring back some manufacturing jobs as well.

So yeah, I think this is a very positive rotation that will continue to give us very robust growth but importantly, we'll sort of diffuse it, right? We'll make it the type of growth that a much bigger portion of the population can participate in from the labor market perspective. And that's what the Fed wants to see. That's what we all want to see.

JULIE HYMAN: Aneta, great to talk to you as always. Thanks so much. Aneta Markowska is Jefferies chief financial economist.