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What the Fed decision says about economic recovery

Wells Fargo Head of Rate Strategy Mike Schumacher joins the On the Move panel to break down the latest decision from the Federal Reserve.

Video Transcript

ADAM SHAPIRO: But we have to talk about the impact from yesterday's Fed decision, and then the subsequent comments from Jay Powell. To help us break it all down on what it means for your investments and for this economy, we invite into the stream once again, Mike Schumacher, Wells Fargo Head of Rate Strategy, joining us from North Carolina. It's good to see you. And was there anything that stood out as a surprise to you yesterday? Because we're hearing investors say it was the lack of direction on the economic recovery and also on inflation that has them upset.

MIKE SCHUMACHER: I wouldn't say surprising so much, Adam, but I think it really is incredible when you look at the Fed's projections out until 2023. And whether they're right or wrong doesn't matter so much. It's the signal that inflation could be around 2%, unemployment about 4%, and the Fed still wouldn't hike. It's mind-boggling. So it really is underscoring just what a big shift in policy the Fed has put in place.

JULIE HYMAN: And so as somebody who trades interest rates, what do you trade on if the Fed is not going to move? And will rates move that much on say, economic data if you know the Fed is not going to move?

MIKE SCHUMACHER: Yeah, it's a terrific question, Julie. And frankly, we would say that day-to-day economic data probably don't matter very much. But if you look back over the last 10 years, it's been a really weak link, frankly, between economic data and interest rates or even equity prices. So going forward, we think it's going to drive long-term rates. And I would define those as, let's say, 10 and 30-year rates, is the massive supply of Treasuries. And think about all the politicking we've heard over the last few weeks. Has any candidate talked about cutting spending? No.

So we think you're going to see the deficit remain very large and Treasury issuance very heavy for a long, long time. And against that, the Fed didn't give any signal yesterday it wanted to buy more Treasuries or more mortgage-backed securities. So it brings to mind the question, who is going to step up and fill that gap? And when there's a lot of supply and not so much demand, we think it does set the stage for long-term rates to go up. But short end rates out to the five year point, we think they're pretty well locked in.

JULIA LA ROCHE: Mike, it's Julia La Roche. Just given your experience in the space, walk us through the Fed's track record when it comes to targeting inflation and how they've been able to do that in the past, and what kind of expectations are in a couple of years ahead now.

MIKE SCHUMACHER: Julia, I would say it's difficult for anyone, whether it's the Fed or for me or someone in my role, you name, any economist type to forecast inflation out more than, say 12 months. And that's why we look at the Fed's forecast yesterday and we're not too hung up on the numbers put out for 2023. The thing that we take away, is that even if those numbers were right and if inflation does some how rise to 2% over the next few years, the Fed still does not want to raise rates.

So maybe their forecasting record is not great, but that's not the big point. The big point is, if inflation ticks up and is anywhere near 2%, but not much over, the Fed probably stays put. So it really is a big shift in the way it views the world.

ADAM SHAPIRO: Mike, that's a big if, since we haven't really had 2% inflation in several years. And your note to us though, and this is along what Julie was asking you, you said that you remain comfortable with your call for a gradual bear steepener in the spread between the 2 and the 10. I'm curious, what does that look like for those of us who don't make our livings having to invest based on these spreads?

MIKE SCHUMACHER: I think what that really means, Adam, is that for most your viewers, the chance to make much money by owning Treasury bonds or something relatively safe, is pretty limited. So if you think about the view that I just laid out, let's say the yields after the five year point stay pretty much where they are, well, that's very low. You've got yields maybe 30 basis points give or take on the five year, depending on the day, and less than that for the shorter maturities.

Inflation's a lot higher. So after adjusting for inflation, you've got a negative real yield. Pretty unattractive. And going toward longer term rates, even the 30 year is maybe 1 and 1/2, depending on the day. So that too, is probably below inflation. So very difficult to earn a positive real yield. So what that means for us, is that I would say most traditional investors probably stay away from Treasuries and other very high quality bonds. I would leave this more in the faster money crowd for the folks who are trying to outperform an index.

But if it's you or I or someone who simply is trying to see a few more dollars in the account at the end of the year, buying Treasuries probably is not the way to do it. Now what Treasuries can do, is they can provide a place to stay safe during a really turbulent time, as we had, for instance, in March and April. But longer term, not [INAUDIBLE].

JULIE HYMAN: Hey, Mike, what about other sovereigns? In other words, we're looking at nations around the world that are probably going to need some money in the coming months, if not coming years. And there was a report out, an estimate out from JP Morgan yesterday that we're going to see a lot of stock selling on the part of sovereigns. Is that going to cause any kind of ripple effect in the Treasury market and in the sovereign bond market at all as well?

MIKE SCHUMACHER: We wonder about this sort of thing quite a bit, Julie, and the idea is that you've got massive holdings of Treasuries and US government securities overseas. China is the biggest one, well, actually number two now, Japan's back to number one. But still, huge holdings. And the issue is, would they really sell? They might sell some. They might sell on the margin. But would they sell enough to have a massive market impact? I doubt it. I could imagine a case where you see enough selling maybe to push up yields by 25 basis points, something like that in the long end.

But right now, if yields were to go up 50 basis points, I could see people come rushing in. And maybe another way to think about this, is that no one loves the idea of buying Treasury yields at these super low yields, but some investors simply have to do it. Maybe it's an insurance company that's trying to offset its liability stream, or perhaps a pension. So if yields were to go up dramatically over the next couple weeks, I think those folks would come in. So probably some selling. Probably not enough though, to make a massive market difference.

ADAM SHAPIRO: All right, Mike Schumacher, it's always good to see you. Wells Fargo Head of Rate strategy. All the best to you and enjoy the weather there in North Carolina. I believe there is some bad weather heading your way, so hunker down and be careful.