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How the Fed plans to avoid the rate hike mistake of 2018

Head of Macro Strategy at Wells Fargo Securities Mike Schumacher joins Yahoo Finance to discuss the future of the S&P 500, the effect of Fed policy within the market, and inflationary pressures.

Video Transcript


BRIAN SOZZI: The market enjoying an impressive August. We have started to see some Wall Street forecasters strike very bullish outlooks for 2022. Our next guest is a little more measured, however. Mike Schumacher is the head of Macro Strategy at Wells Fargo Securities.

Mike, good to speak with you again here. I want to dive right into your targets. So your year end price target for the S&P 500 4,825 So still somewhat bullish, I would say. But next year, you're looking for 4,715. Why do you think the S&P would tread water next year?

MIKE SCHUMACHER: Yeah. The S&P has got some challenges next year. And it's interesting. Talking to our equity team Chris Harvey quite a bit. We consistently go back and forth about the role of the Fed. And we think the Fed is going to take away or at least reach for the punch bowl fairly soon. Maybe not in September, maybe not even November, but probably by December.

And that's probably going to have a tough effect on equities. And if bond yields go up a little bit 10, 15, 20 basis points, maybe doesn't matter so much. But a more likely case, in our view at least at Wells Fargo, is 30, 40, 50 basis points. And that's a tough call for the equity market to swallow.

MYLES UDLAND: You know, Mike, the outlook that you guys have, just staying on the equity market for a second, is looking essentially for no multiple expansion. And we have kind of seen that already. So far this year. I'm curious how you've made sense that in conversations you're having with folks who might be saying, the market's going too far, too fast. But really, it's being underwritten almost more than completely by what we're seeing on the bottom line from companies.

MIKE SCHUMACHER: Yeah, the bottom line. And also, I think it's interesting, Myles, if you think about the funding side, money's cheap, bottom line. And if you want to look at that, consider the-- let's say the old fashioned Fed model, and consider not PE, but earnings to price, and compare that to let's say the yield on the corporate bond index, it looks fine. The equity market looks relatively reasonably priced.

So not too far out of balance, but we do continue to go back to the bond market and funding is the underpinning for this enormous surge. In particular, this month is a good example. Growth has done very well. Value not so well. Mega caps doing particularly well. I think that speaks volumes to the benefits of low yields.

BRIAN SOZZI: Mike, looking at next year, if we reach that point, later in the year or whenever it might happen, that the pandemic is-- we have fully rounded the corner, what would that do to your S&P 500 target?

MIKE SCHUMACHER: Yeah. It's an interesting point, Brian. When you think about the concept of rounding the corner, I thought we'd probably be there at this point. We're not. And looking forward, if that were to happen, should be a positive in many ways.

Now, one caveat though is you, again, have to think about the policymaker response. So not just with respect to monetary policy, but fiscal policy in the US has been incredibly stimulative over the last year and a half. Does some of that wind down? Does it continue? So it's not so easy to say simply that if the pandemic gets to a much better spot, equities do exceptionally well. They've had huge tailwinds of their back on the policy side so far.

MYLES UDLAND: So kind of thinking about, you know, the fixed income market, really, the Fed fits in there. You know, any way you cut it, we're going to see tapering by January/February 2022. So let's call it end of next year, the Fed is done with that process. As you look through Fed commentary in the last couple of weeks here, how careful do you think the Fed will be this time around as it embarks on its rate hiking cycle, given that I think Powell views some of what they did in '17 and '18 as a policy mistake of a sort?

MIKE SCHUMACHER: Yeah. That's a good point. I think it's fair to say that Powell views the last rate hike in 2018 as a mistake. He was almost apologizing for that a few weeks after the fact at a conference with Bernanke and Yellen. So doesn't want to go too far.

And an interesting thing for the Fed this time around, Myles, is it's got this strange new framework called targeting average inflation. What does it mean in practice, we don't really know. But one implication could be is the Fed keeps the funds rate very low for a very long time.

Now, thinking back to the last go around, the Fed announced tapering at the end of 2013, began in early 2014. Its first rate hike was not until December of 2015. That was only 25 basis points. And the second one was a full year later.

So even in that cycle, the Fed went very, very slowly in terms of raising rates. It might go equally slowly and maybe even ease back slightly from there this time around. So it could be a very, very slow, gradual march upward. I think that's the lesson the Fed's taking away.

MYLES UDLAND: Yeah. And you talked about that average inflation target. What are you thinking about the transitory argument? How do you guys see it at this point in the cycle? Some of those pressures maybe appearing more transitory. Others perhaps more durable. What are conversations you guys are having internally and with clients who maybe are skeptical of this line from the Fed?

MIKE SCHUMACHER: Yeah. We're skeptical and clients are skeptical, generally. And it's interesting if you think about the various factors contributing to inflation, I think you've got to assess two questions. So one is how rapidly does the inflation surge end? We think it's already fading, but how quickly does it come down to a more typical level? Secondly, what is that equilibrium, let's say out 12 months, 24 months? We think, in both cases, the Fed is going to be disappointed.

When you look at the labor market, there are a lot of pressures. A lot of people are hanging their hat on the idea that next month you'll see many people come back to work. This deficit of 5 million jobs that Powell talks about quite a bit will go down substantially. Maybe that happens, but we don't know yet.

You've got a lot of pressures on the transit side. Record number of ships waiting outside the LA and Long Beach ports to get in. Lots of pressure points. And that tells me that these things don't get all eased at the same time.

So it's going to be a while. The markets are priced somewhat for that, but probably not as much as the Fed thinks will happen.

BRIAN SOZZI: Yeah. We gotta get those containers over here, Mike. I think my next pair of jeans is collecting dust in them. Gotta get them over. Got to alleviate those pressures.

Mike Schumacher, head of Macro Strategy at Wells Fargo. Always good to see you. Have a great Labor Day weekend.

MIKE SCHUMACHER: Thanks, Brian. Bye now.