Fed: No rate cuts on the horizon, strategist says

Wednesday's CPI data is expected to show inflation rose in August, with economists expecting an increase of 3.6%. The Federal Reserve has been raising interest rates in a bid to bring inflation down to 2%, but the recent increase in oil prices could complicate things. Verdence Capital Advisor's CIO Megan Horneman weighs in with Yahoo Finance's Julie Hyman and Akiko Fujita explaining how oil prices may not have an immediate impact on inflation, but they could as they work their way through the supple chain. Horneman believes that the Fed will pause in September, but "we do think there's much more likelihood of another rate increase at some point this year and we don't think rate cuts are anywhere on the horizon."

Video Transcript

JULIE HYMAN: Well, let's get a check of stocks today, as investors are counting down to Wednesday's key inflation data report. The Dow's been bouncing between gains and losses. But overall, the tenor a little more negative here.

Joining us to discuss what to expect from CPI, and how it might affect the Fed at next week's FOMC meeting, is Megan Horneman, Verdence Capital Advisors' chief investment officer. Megan, good to see you. As we look at this inflation outlook here, one of the things that our Jared Blikre was talking about earlier is the input of oil and higher oil prices, and how maybe that's going to feed through to inflation. Could we be in for maybe some unpleasant surprises, if not at tomorrow's report, maybe next month's?

MEGAN HORNEMAN: Yeah, I do think that this is going to continue for the next couple of months. Energy can be very volatile in the CPI report, but it's not just energy. I don't know if you've had a chance to take a look at some of the other economic data that we've gotten out over the past couple of weeks. Starting with the NFIB survey yesterday, where selling prices or their plans to increase selling prices, that rose after eight consecutive months of declines.

If you look at the ISM Services index, those prices paid also rose. These are things that we think is something the Fed's not going to like. We can't pinpoint exactly when it'll start to filter into CPI data, but we do know that energy can have quite a bit of volatility. We think it's going to start tomorrow. And I think we'll continue with that over the next couple of months.

AKIKO FUJITA: Yeah, so that has been the question. I mean, how big of a risk do you think energy prices pose to re-acceleration of inflation? That's always been kind of choppy, but is there a concern that these rising prices, at least this most recent cycle, could be a little stickier?

MEGAN HORNEMAN: I think, again, people will look past if you get a tame core number tomorrow and you get a headline number that kind of comes in line with consensus, which is already expecting it, I don't know that the market's going to move significantly on that. And I don't think that energy is going to have such an immediate impact. This is something that all, of these things combined together, could create an increase in the core inflation in the next couple of months. And that's what the Fed's going to pay a lot of attention to.

JULIE HYMAN: And so then what do you do as an investor here, right? Do you think that we are going to continue to see bond yields either at these levels or even higher, which seems to be a little bit of an obstacle for this continued rally in tech stocks, for example?

MEGAN HORNEMAN: Yeah, I do think that what investors have to realize is whether or not the Fed goes-- they stay on pause in September next week, which we do think is the case. But we do think that there's much more likelihood of another rate increase at some point this year. And we don't think rate cuts are anywhere on the horizon. So when it comes to tech stocks, as you mentioned, and they're being impacted by higher yields, they have to understand that yields are going to be higher for longer and may even go higher from here.

We think valuations aren't pricing that in. And that does still concern us from investing in these heavy tech stocks. You can see at some of the news that we've gotten over the past couple of weeks when it comes to technology, whether it's earnings or product releases, these stocks are priced in for perfection. Any negative news, we see a lot of volatility in these stocks. So we still would be cautious there.

AKIKO FUJITA: We're looking at another potential for a government shutdown if, in fact, we don't see this October 1 deadline come through and Congress doesn't approve proposed spending bills in time for that. How big of a market event would that be?

MEGAN HORNEMAN: We've seen this happen quite a bit, unfortunately. So I don't know if it will have long-lasting ramifications in the market. But it is something that will just be-- another thing that tests sentiment. There's a lot of negative things that are just looming out there.

I know that there's a lot of talk about how strong the economy is. But let's not forget, we haven't absorbed the Fed tightening cycle fully yet. The banks, they've been out in the news a lot more lately about the tight-- not only do they have tight lending conditions because of what happened in the first quarter of this year, but now they're having additional regulatory scrutiny as well.

These are things, as well as just the strain on the consumer with the increase in interest rates. Credit cards, the reliance on credit card debt, all of this stuff will eventually come to fruition, and the economy is not going to be able to sustain these levels of growth that we've seen.

JULIE HYMAN: Do you think that stocks are properly discounting all of that, all of those factors you've talked about? I mean, we have seen a little bit of a pullback here, but is it enough of one?

MEGAN HORNEMAN: No, I don't think so at all. And I think the one thing you'll start to see is that those 2024 earnings estimates are too high. We haven't really seen them come down enough, given our expectation that the economy is in for a tough road ahead in the remainder of this year, as well as especially the first half of next year.

AKIKO FUJITA: Finally, before we let you go, I'm going to have to ask you about where your positioning right now. I mean, where do you think-- what are some sectors you think are being overlooked right now, where you think investors can find particular value?

MEGAN HORNEMAN: Right now, we would be defensive. So stick with some of those defensive sectors, especially over whether it's consumer discretionary or technology. We still like cash, having a overweight cash position, being ready to put money to work.

We think other areas like energy might be getting a little ahead of itself. So we're remaining very cautious. Defensive sectors over those cyclical and growth type of sectors.

JULIE HYMAN: Where specifically is defensive for you right now?

MEGAN HORNEMAN: Broadly, it's cash. I know that's kind of boring for some, but let's be honest, we're paying 5% to 5.25% on cash, if not higher. So defensively, that's where we are in cash. Staples, I think, are another area over something like discretionary.

Your generally traditional defensive sectors that should be able to withstand the economic downturn. Be very careful of some of those other ones that are way too dependent on the consumer, way too interest rate sensitive, and stick with those kind of boring, old, traditional defensive sectors.

AKIKO FUJITA: Megan Horneman, Verdence Capital Advisors' chief investment officer. Good takeaways there. We really appreciate the time.

MEGAN HORNEMAN: Thank you.