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Fed told markets, ‘no pivot,’ economist says

Meera Pandit, J.P. Morgan Asset Management Global Market Strategist, and Joe Brusuelas, RSM Chief Economist, join Yahoo Finance Live to discuss Fed Chair Powell's Jackson Hole speech and the outlook for the economy.

Video Transcript

AKIKO FUJITA: Let's keep that conversation going in studio here. We've got Meera Pandit, JP Morgan Asset Management global market strategist, and Joe Brusuelas, RSM chief economist, joining us here. And Joe, let me kick things off with you. As Brian said, this was an unusually short speech. I mean, I had to look at the clock to say, oh, he's already wrapped up. But it was a very clear one with the Fed Chair saying essentially, look, it all comes down to inflation, even if it means unemployment could tick higher.

JOE BRUSUELAS: Right. What you saw Jay Powell today was-- do today was to deliver the hard line on inflation. I wouldn't call it if you do a spectrum of 1 to 10, I wouldn't call it a 10 in terms of the hawkish meter, but it was a good 5 or 6. So I think that this is important. He basically was telling market participants no pivot.

Moreover, the underlying message that I took away from this was twofold. One is for market participants, lift and hold. You're going to see the policy rate move. I think it should go up 75 basis points. And they need to get to restrictive terrain as soon as they can. I think we need to get to 4% by the end of the year.

And then the second, this is the bigger takeaway, I think, is that we're moving from an era of insufficient aggregate demand to one of insufficient aggregate supply. We're all going to have to adjust to it because it's going to require very different policies. For the next three to five years, we should all set expectations around, we're not going back to pre-pandemic era levels of inflation or interest rates.

And this is going to require a structural adjustment, not only for those who participate in the markets, but for the public and policymakers. Monetary policy is just not something that can deal adequately with supply shocks, which means we're going to need the fiscal authority to dive in here, especially around housing, where we have a woefully inadequate supply of housing.

AKIKO FUJITA: Meera, you agree with that? I mean, are there some meaningful structural adjustments that the market's really just going to have to brace for?

MEERA PANDIT: This speech was very much a greatest hits of the last couple of weeks of Fed speak and of FOMC minutes in which they reiterated, we're going to have to go to restrictive territory. The time that we need to spend there is going to heavily depend on how fast we can get there today. We're not ready to pause. And yet, at the same time, still another larger than usual unusual rate increase may be necessary in September. But it's going to be very data dependent based on CPI and jobs.

So I think it was very much a reiteration of the narratives and weaving some of those themes together. To me, the goal of this was to tighten financial conditions and to get markets back in line with expectations of what the Fed intends to do. And ultimately, we're seeing stocks down. We saw the two-year hit recent highs again. We're seeing the 10-year move higher. So in that way, it did achieve this increment step to get to September.

AKIKO FUJITA: What does it mean, Joe, for broader macroeconomic conditions? I mean, on the one hand, we've heard the labor market is strong, and we have seen the numbers support that. And yet, the Fed Chair saying today that look, if it is about inflation, Americans are going to have to feel some pain.

JOE BRUSUELAS: That's right. What it means is that the Federal Reserve is going to have to engineer a set of financial conditions that are restrictive. That means higher unemployment. That means millions of people are likely to lose their job in 2023 and 2024 before inflation is meaningfully put into a place where they can begin to back off. I think that once the Fed gets to 4%, maybe a little higher, they're going to engage in a pause to ascertain the impact of past policy.

In many ways, they only started lifting rates this year, right? I mean, the true tightening began in January. Usually, you get a 9 to 12-month lag before it begins to show up in a meaningful way. You're only starting to see it on the edges primarily in the housing market, which is where you would expect it. Housing and then manufacturing writ large, autos in particular. So you'll begin to see that quite soon.

AKIKO FUJITA: Meera, when you look at the market reaction, I mean, we were talking about this going back to the last meeting that there may have been some misinterpretation that came out, the expectation being that, look, maybe the most aggressive part of the tightening cycle is sort of behind us. And it felt like the expectation that kind of rushed ahead to say, well, next year, maybe there will be cuts. Is this a resetting of expectations we're seeing today?

MEERA PANDIT: We've seen this gap in market expectations and Fed expectations, specifically more for 2023 even than where we are today. But I think that Chair Powell's comments about we're not ready to stop, we're not ready to pause, we're important for the market to hear in a very direct fashion to realign some of those expectations for the rest of the year. And we're likely to see a pretty rangebound market the rest of the year, given that there's not a whole lot of bullish catalysts from here. And if this was going to be the big one, we had to throw a little bit of cold water on that in order to bring things back into line.

I think what we'd look for September is to get a little bit of a better sense on what happens next year because those expectations still need to come in to line. Now the challenge with the dot plot is you don't get a great sense of chronology. We very well could be in a position where the Fed needs to continue to hike in the beginning of 2023, but perhaps put in a cut by the end. It's very hard to read that in just the dot plot. So it would be interesting to see the tact that the Fed takes in September with their forward-looking projections to get the market in line for next year.

AKIKO FUJITA: And on the expectation front, I mean, if you look at where the market's moving today, obviously, the major indices down, too, but we have seen broader risk-off sentiment moving in. Money moving out of tech when we were just saying a few weeks ago that things are moving back in. Is that sort of what we can expect going into year end?

MEERA PANDIT: Yeah, when you see some of these more speculative rallies, you have to question the durability of them. And not to say that areas of tech or even consumer discretionary are necessarily speculative in nature, but certainly the fundamentals over the next couple of months are going to be challenged. So when we see those types of rallies, perhaps it can be a little bit of a relief for investors overall. But you have to question the durability of them and consider what has changed fundamentally.

And so far, while we've gotten a little bit better inflation data, a bit better on jobs data as well, that doesn't necessarily suggest a fundamental shift yet.

AKIKO FUJITA: And finally, Joe, the larger question, I think, a lot of viewers keep asking is, are we headed towards a recession? I realize there's a lot of debate about the technicalities of that. But what we heard from Jay Powell today, does that shift your expectation at all?

JOE BRUSUELAS: Well, I had a 45% probability of a recession over the next 12 months. So my position won't change. No recession this year, but the economy could plausibly fall off the cliff next year. Look, 2022--

AKIKO FUJITA: What do you mean when you say, fall off the cliff?

JOE BRUSUELAS: So when the US economy goes into recession, it's not a big battleship. It doesn't turn slowly. It tends to fall off a cliff, right? So we clearly aren't seeing those conditions. Next week, you're probably going to see a jobs report that generates around 400,000 new jobs. So we're clearly not there.

Now, next year, though, is going to be a very mean year. You know, what's going on in Europe right now, they're either at or will soon be in recession. Our friends over in the UK, they're going to have a 13% rate of inflation probably by the end of next year. It'll be closer to 15% in the first quarter. You're going to see capital flows are going to be coming into the United States, and it means your safe haven move. And that's going to be one of the big market stories, I think, as we go into the final portion of the year.

AKIKO FUJITA: Yeah, a big warning for 2023 as well. Joe Brusuelas, appreciate you always joining us, as well as Meera Pandit, JP Morgan Asset Management global market strategist.