PGIM Fixed Income Lead Economist Ellen Gaske joins Yahoo Finance Live to discuss the Fed's latest rate hike and what it could mean for the economy going forward as it grapples with inflation.
SEANA SMITH: Well, again, let's take a look at rates here in terms of treasuries because we're seeing some movement in the yields. The 10-year yield spiking to the highest level that we have seen in just about 11 years. The two-year yield now just around 4.11%, again, the highest that we have seen since at least 2007. We want to bring in Ellen Gaske. She's PGIM's fixed income lead economist. Ellen, it's great to see you. In terms of your reaction to what we just heard from the Fed, what we just got from Jay Powell, a 75-basis point hike, is that enough?
ELLEN GASKE: Well, the 75-basis point hike today was expected. I think, though, their projections, it looks like they pulled forward their expected rate hikes a bit from what we and the markets were expecting. They've got basically another 100-- up to 4 and 1/2% by the end of this year, a little higher than we had expected, and critically signaling that they expect the funds rate will stay high, maybe even move a bit higher next year as well. So persistently tight policy here through the next year and a half.
So it was a little more aggressive, I think, than expected. The unemployment rate a little bit higher projected from the Fed than I had anticipated. So they are signaling they are serious about this. Critically, though, if you look next year with a 4 and 1/2%, 4.6% Fed funds rate they're projecting, they're also expecting inflation will moderate. The PCE deflator, their preferred measure, down to 2.6%. That means next year, their funds rate will be outpacing inflation finally. They will be sufficiently restrictive.
RACHELLE AKUFFO: And a lot of people are wondering what this means in terms of GDP projections that are out now. What's your take on what we can expect then, given some of the pressures that the Fed both can and cannot control?
ELLEN GASKE: Yes, so it was expected that they would bring down the GDP forecast for this year down close to zero, which they did. By the way they measure it, they look at fourth quarter to fourth quarter growth rates. Last year's fourth quarter was extremely strong. Since then, the economy's been a bit treading water, as we know. So if you compare fourth quarter of this year to last year, it's going to look about flat.
But underneath that, underlying that, I think the household sector in aggregate is still in really good shape. We know that their balance sheets in aggregate are good. And corporates critically, businesses, profits have been more resilient, margins more resilient than expected. Companies have been willing to continue to spend, hiring, investing in equipment and software, much needed investment in the supply side of the economy that's going to ultimately be part of the solution to these high inflation pressures.
So overall, there's a chance here still for a soft landing. But the Fed is moving so rapidly against rapidly changing domestic and global conditions, admittedly the risks of recession are elevated at this point. And given the aggressive pace of the Fed and other central banks, recession risks are now higher. The soft landing, that's a very fine needle that has to be thread here.
DAVE BRIGGS: What does the Fed need to accomplish that?
ELLEN GASKE: Well, I think we need to see some rollover in these inflation pressures, a natural rollover, that I think we've been seeing nascent signs of. But it's-- inflation has been more persistent than expected. We had an inventory cycle now finished playing out. That put pressure on production and demand while companies were restocking shelves, alongside households and businesses reopening and the COVID boost from them. But that's now played out. The fiscal stimulus has played out. The drag from its end-- from its end has also now played out.
So I think the very volatile fiscal policy should dissipate. And that would go a long way, I think, also to put us on an even keel here. But again, the global backdrop is one of elevated risks. Global energy prices, right now they're cooperating with demand destruction from China, from Europe. The softening of energy prices, oil prices, is really helping US consumers. But that is at risk here this winter going forward. So it's going to be challenging. It's not impossible for a soft landing, but certainly challenging.
DAVE BRIGGS: And I guess what I was getting at, Ellen, is, beyond their control. Let's say an end to the hostilities in Ukraine, the COVID China lockdowns. Is there something that could change this equation dramatically for the Fed?
ELLEN GASKE: Yeah, so I keep looking towards what's going to happen to companies, and they're willing to invest. To me, that's the long-run solution here that would boost growth and dampen inflation pressures. If the Fed hits the brakes so hard here that companies start to pull back and pull back quickly, hiring not just slows but really dries up, the labor market is decimated, that means that the supply side of the economy is really going to freeze up. And that's something that's been so different in this cycle, the challenges on the supply front.
The Fed trying to dampen demand conditions has to be careful that it doesn't inadvertently too much dampen the supply side. The housing market is a key example, where the froth is coming out of it. We've seen existing home sales decline now seven months in a row. Demand is slowing. But it's been a tight market for over 10 years now, very challenged in terms of supply. And Fed tightening could inadvertently slow down much needed additional new housing to feed into the millennial, Gen Z demand.
Similarly in the labor market, a softening would help wage pressures soften a bit here. But a strong labor market helps pull people off the sidelines, much needed additional labor as boomers are hitting peak retirement years. So the trick here is to not tighten so much that it discourages much needed additional labor supply. Infrastructure, in terms of the production and distribution of goods, we've seen that-- we've seen that be still challenged. There's a lot of investment that needs to take place in this new environment.
And again, the Fed's got to be careful here. If the Fed does achieve the soft landing, it's that supply side that I look to, it's companies willing to invest on an ongoing basis, that holds open the possibility for a longer expansion than most are anticipating now.
SEANA SMITH: And we'll hear from Fed Chair Jay Powell in just about 13 minutes from now. He has been optimistic that the Fed will be able to get inflation under control. From your view, when do you expect to see a significant, meaningful decline in inflation?
ELLEN GASKE: Well, what I'm looking for primarily is how broad-based the inflation pressures are. And we did, for one month, see the breadth of decline. And that, to me, was a hopeful sign. But that went out the window with last month's print. So I'm looking for continued high inflation in rents, homeowners equivalent rents. That's something that's baked in the cake that will stay elevated for a while.
But offsetting that, I want to see softness in goods prices. The seeds have been sown for that. Shelves have been restocked. The Fed has tightened a lot. It's hard for consumers to run up a credit card and not pay a higher interest rate. The seeds have been sown for a softening in those goods prices. That's what I'd be expecting to see going forward. It may take into next year, which is what the Fed is signaling they expect. So that keeps the Fed in hiking mode from here.