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Fed: Traders ‘on red alert’ after June inflation data, economist says

Abrdn Deputy Chief Economist James McCann joins Yahoo Finance Live to discuss June CPI, Bank of Canada's significant rate hike, and how central bankers are contemplating inflation data.

Video Transcript

[MUSIC PLAYING]

BRIAN SOZZI: The June Consumer Price Index came in red hot. The headline number hitting a 9.1% increase, notching another 40-year high. Joining us now for more on this is James McCann, Abrdn deputy chief economist. Good to see you here, James. What do you think this means for the Federal Reserve's next move?

JAMES MCCANN: Well, I think they're definitely going to go big. And I think the key question is, how big do they go? They signaled 50, 75 basis points. Maybe now even 100 is on the table.

BRIAN SOZZI: Is 100 big? We can call that big, right?

JAMES MCCANN: I mean, I think we can call that big. I mean, it's historically really big. I think it's on the table. I don't think I'd have it as my base case yet. And we want to be watching for what the Fed says. But even as we get closer to the meeting, even as we get through the blackout period, as we know from previously, they could surprise and just sneak into the market somewhere that a bigger hike is coming. So I think trade is going to be on red alert for a bigger move from the Fed following these data.

JULIE HYMAN: Speaking of surprises, speaking of red alerts, Bank of Canada just raised by 100 basis points. So, and that, I believe, was a surprise move. And their rate of inflation isn't even as high as it is here. I think they were 7.7% in May. They haven't yet reported for June. Does that sort have any implications for what the Fed may do as well? Obviously, they're not following, but still.

JAMES MCCANN: I don't think there's a direct read to cross necessarily. They're approaching their own domestic situation. But what I do think it's representative of is this, if not panic, deep degree of alarm among central banks, having allowed inflation and got behind the curve of inflation, and now seeing when they maybe expected some of the underlying inflationary pressures to have peaked and starting to ease, just really continued strong of high-- broad and aggressive price growth.

And they don't want to be the central banks that gave us another 1970s. They're really, really focused on getting this down. And I think what we're seeing across the board is a preparedness to move pretty quickly to get that done.

BRAD SMITH: And so if we do see a historically significant type of increase at this next meeting from the FOMC, how much more difficult does that make the path for a soft landing in the economy?

JAMES MCCANN: Yeah, I think it's just increasingly challenging. The more aggressively you're forced to raise policy in response to the fact that these inflation imbalances aren't cooling by themselves-- we're not seeing the supply side ride to the rescue, so you're having to do more of the work with demand dampening, interest rate tightening-- you know, I think that just makes it more challenging.

And what we're seeing in markets, the feedback loops that this is generating, the financial stress, you know, already, when we model that, that's enough to take around two percentage points off US growth over the next year or so. And we've still got further tightening to go. So I do think there's still a path for a soft landing. But I think that's a pretty narrow path at the moment.

JULIE HYMAN: Now, we just talked to the White House Economic Council director Brian Deese a few moments ago. And the White House message has been on the CPI report, it's from last month. Gas prices have come down. Energy prices have come down. We're on the correct path. Is that reassuring to you? In other words, do you think that energy prices are going to stay down and stay down enough to then help out the overall inflation picture?

JAMES MCCANN: Look, I think energy prices will stay down. And I think that means on the headline rate, we're past the peak. But I really will be careful about saying that we're out of the woods by any means. Actually, when you look at the details of this report, core services inflation is what's most alarming. That's really, really taking off. And so you can look at energy forwards and say, oh, it's fine. We're going to get cheaper gas prices over coming months.

And that'll mean that we're probably at the peak in the headline. It's core that I think is the problem. You know, and that's growing very strongly across services and goods. So I don't take a lot of comfort from that, to be honest.

BRIAN SOZZI: If the Fed, like you mentioned, comes out here and goes big, 100 basis point rate hike, does that, at its next meeting, does that set the table for negative growth for the full year in the US? Because look, I mean, they've already been out here aggressive with rates, even before that potential increase.

JAMES MCCANN: I don't think we'll get sort of a negative GDP print through the rest of this year. I don't think we're going to go into recession in 2022. I suspect what we're seeing at the moment, a big energy price shock, and that's generating something of a soft patch. I think when we look at underlying growth, the labor market still looks pretty healthy to us.

Spending is slow, but it continues to run along at reasonable rates in a trend sense. So I think the economy can hold up through this year, but really, we're concerned about 2023 with that continued tightening and some of those lagged cyclical effects, some of that financial stress biting in. You know, I think we're really concerned that we'll see a recession next year.

JULIE HYMAN: Finally, you being at a UK-based bank, even though you are based here in the US, I would be remiss if I didn't ask about what's happening over in Europe as well. And particularly, now, we're seeing euro-dollar parity. We are seeing a lot of concern about economic weakness there. How does that, then, feed through into the overall economic picture?

JAMES MCCANN: Yeah, I mean, I guess, one of the key differences there is you've just got this gas price channel as well. So it's-- sort of natural gas, right? So it's not just prices at the pump, which have been rising very significantly. You've got a bunch of gas price increases to come through the channel. And some of them haven't been felt yet because you have regulatory stopgaps, which mean that they don't come through until those caps are increased.

So, really, it's just an even tighter dynamic in Europe, whereby you've got this big squeeze on consumer income, very negative to growth, but very high inflation. So if anything, the Fed's in a really nasty spot. I think the Bank of England, the ECB. I think central banks in Europe are in even more difficult spot because they've got to judge this balance between tightening policy to control inflation, but with really, really big inflation headwinds hitting consumers, households, businesses.

You know, I think that's going to be really challenging for them to pull off, to be honest with you. A chance we think the US can make it through this year. I think the eurozone and UK, they're definitely flirting with recession in 2022.

BRIAN SOZZI: Well, the big question is, what is the office pool? Who's going to win the Open Championship? I mean, do you guys have Tiger winning at all?

JAMES MCCANN: I'm not sure we're backing that necessarily, but my forecasts--

[LAUGHTER]

BRIAN SOZZI: Fair enough. I'm gonna ask tough questions here. Well, James McCann, Abrdn deputy chief economist, good to see you again. We appreciate it.

JAMES MCCANN: Thank you.