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Inflation conditions ‘are morphing,’ strategist says

J.P. Morgan Global Wealth Management Chief Investment Strategist Thomas Kennedy joins Yahoo Finance Live to discuss inflation, supply chain pressures, market expectations for Fed policy moves, and the probability of a Federal Reserve soft landing.

Video Transcript

JULIE HYMAN: Welcome back. As we've been talking about, Fed Chair Jerome Powell is speaking at a Cato Institute conference this morning. And he is reiterating much of the same sentiment that he has talked about before, Sozz. He talked about that the Fed needs to keep at it until the job is done on inflation. He says history cautions against prematurely loosening policy.

And this is sort of an echoing of the comments that we saw and the sort of tone that we saw yesterday morning in Nick Timiraos' story in the Wall Street Journal, where he basically reported that the Fed was not happy with the market reaction that it had seen, that the market was being too sanguine, perhaps, about what was going on with Fed policy, its reaction, its reading of Fed policy.

BRIAN SOZZI: All right, let's get-- or just stay on that market reaction here. Joining us now for more is Thomas Kennedy, JP Morgan Global Wealth Management chief investment strategist. Good to see you here this morning. So we've started to get some comments from Jay Powell. What's your take?

THOMAS KENNEDY: Good morning. I think Jay Powell is trying to reiterate that the conditions for inflation are morphing, and they have changed dramatically since the start of the year. What started as a supply chain issue is morphing now into a demand problem on inflation. Most of my clients still want to talk about supply chain pressures that they'll see in their business, but we try to aggregate across all indicators you might find, including delivery times, inventories. And it looks like the supply chain issues are gone. They've been resolved.

When you flip over to the demand side of the economy, though, the labor market is very tight. And I think Jay Powell is really leaning in on just because the supply side of the economy is normalizing doesn't mean the Fed will be able to back away from its tightening cycle.

BRIAN SOZZI: Thomas, what's the level of confidence when you talk to investors on the Fed engineering a soft landing?

THOMAS KENNEDY: I would say it's about a coin flip at this point. When I'm talking to my clients, that's how they feel. But when you survey-- when you look at surveys of the C-suite or of economists, this is a base case now that-- I would call a shallow recession is base case. A recent consumer confidence survey shows that CEOs, 80% of them expect a recession in the next 12 to 18 months. And when you look at economists, as you're showing on the screen here, they're saying about a 50% probability.

The next question becomes, is it shallow? Is there more deep recession? I really don't see merits for a financial crisis. The banking sector has adequate capital. Liquidity has been driven substantially higher. So I don't see a forced deleveraging like we saw in 2008. And then you start to navigate between those two. And I think that's what the market's really toggling with. Do we need a really deep recession to calm inflation here?

JULIE HYMAN: Well, to your point here, Thomas, you, as your note said to us, what's in the price? That's really the key question here. As you say, the markets are struggling with it. As I mentioned coming in to this, effectively, it seems as though the Fed does not think that equities, at least, have priced this appropriately. So what does that then look like, that process?

THOMAS KENNEDY: Yeah, our investment committee meetings start exclusively with what's in the price. I feel like most investors want to talk about what they think is going to happen, and they feel confidence that they can adequately predict that. But we start with what's in the price. And when we do the big zoom out of what's in the price, I see a market that is priced to a soft landing. That the inflation problems are gone and that it won't take much economic pain to do that.

So how do we do that? We can look at where trader professionals think inflation will be over the next 12, 24 months, five years, and so on. And they're all pricing that inflation will go back to 2% across all of those horizons. And then when we try to see what's in the S&P, you're talking about average multiples, no decline in expected earnings from a consensus perspective. So, little economic pain to cure inflation. Now, to be fair, I do think that is possible. But I think we should be skeptical. And I think that's what the market is really toggling between.

BRIAN SOZZI: Thomas, a lot of investors are sitting on some sizable losses from this year-- tech, industrials, all those sectors. What type of tax related moves do you think they'll make into year end? And what impact might that have on markets?

THOMAS KENNEDY: Yeah, I mean, everywhere, people are sitting on losses, right? Bonds and stocks have-- it's been a really painful environment for 60-40. Tax loss harvesting is a strategy that we're using constantly with our clients and trying to make it operate in the background.

Wall Street has moved towards this type of strategy over the last couple of years so that you don't tend to see dramatic moves at the end of the year. So I'm not expecting it to be a really big impact towards the end of the year. But tax loss harvesting is a key aspect of this market. I just think it's happening more perpetually in the background.

JULIE HYMAN: Thomas Kennedy, JP Morgan Global Wealth Management chief investment strategist, thanks a lot this morning. Appreciate it.