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Inflation data reinforces a ‘75-basis-point rate hike’ at Fed meeting: Strategist

Gurpreet Gill, macro strategist of global fixed income at Goldman Sachs Asset Management, joins Yahoo Finance Live to discuss the Fed's path toward a soft landing and the economic outlook.

Video Transcript

- Now on to the bond market. Yield curve inversion persists, with the 2-year sitting above the 10 year by about 39 basis points. And that is amid fears the US economy will be driven to a protracted slowdown. Short-term bonds are particularly sensitive to the Fed rate hikes. And the central bank is expected to deliver a 75 basis point rate rise next week.

And joining us now is Goldman Sachs Asset Management global fixed income macro strategist Gurpreet Gill. And thank you for joining us here today. Just want to get your take on the latest data out this morning. Retail numbers beat on the headline. We dug into it on a little bit deeper basis with our previous guest. But overall, how is the economic picture shaping up for next week's Fed meeting?

GURPREET GILL: Yeah. We would say that on balance, the recent data does reinforce the case for a 75 basis points rate hike next week, as you mentioned. If we take a status check on the US economy, we've had 2.25% of rate increases this year. And broadly speaking, there are three check points on that narrow path to a soft landing that the US is currently on. The first is sustained declines in GDP growth. We have seen progress there.

The second is rebalancing of the labor market. Now, there progress has been slower. The August labor market report earlier this month did encouragingly show an uptick in labor supply through an increase in labor force participation. Job openings and job growth has slowed. But big picture, the labor market is still remarkably tight. And there are 5.2 million more jobs than available workers. And that jobs-workers gap we estimate needs to decline to around 2 million in order for wage growth to fall from 4% to around 3 and 1/2% and be consistent with 2% inflation.

And then the final step in that path is large declines in inflation. And unfortunately there, progress has been much slower. And in the August CPI inflation report this week, we saw continued broad-based strength, particularly in services-related items such as rents. And so, overall, given this limited progress, we have seen Fed officials dial up their hawkish rhetoric. And that's also why we have dialed up our expectations for Fed tightening this year. So a 75 basis points rate hike next week and then two other 50 basis points rate increases later this year.

- Two more. So we're ending somewhere around 4.25%. That's quite a bit. I want to ask you because the bond market several months ago was pretty quick to start pricing in rate cuts at the beginning of next year. We've moved on beyond that because of some of the interim data. But I'm just wondering if we look out to maybe the end of next year, still realistic to think that the Fed is going to be cutting rates any time within the next 12 months?

GURPREET GILL: Well, we've moved from an era of central banks providing forward guidance to this era of data dependence. And that means that markets are volatile and responding to data as it comes in. And that data in this post-pandemic era is sending conflicting signals. So at the start of the summer, there was hope that inflation was easing and there would be a Fed policy pivot. That changed by the end of the summer.

Then at the start of this month, we had an encouraging labor market report, which, like I mentioned, showed an increase in labor supply. And, therefore, market participants expected a slower pace of tightening. And then just this week, we've shifted back to that hawkish outlook. And so I think it's very difficult to make a call on where policy will be next year given the data dependence. For now, we think the Fed is going to stick firmly to its hawkish hiking path. We do think that risks are skewed towards that hiking cycle continuing into early 2023. And for now, it does appear like continued hikes is more likely than a shift to a policy pivot.

- And let me ask you about quantitative tightening. As of this month, that is being ratcheted up to the full amount of $95 billion per month. And there are concerns out there that there is not the cash needed, I guess, in the system and in the money markets to be able to absorb that supply. And I'm just wondering what your view is from a fixed-income perspective is of the quantitative tightening process. Do you think it's too aggressive at this point? Do we simply not know what the effects are going to be?

GURPREET GILL: Well, I would say, big picture, we have not experienced this degree of monetary tightening for several decades. And so it is unprecedented. We've seen the early part of quantitative tightening be passed through relatively smoothly. And so we're going to have to monitor what happens. But big picture, quantitative tightening is intended to occur in the background. I think it was Janet Yellen that likened it to watching paint dry. But it is part of a broader desire of central banks to tighten financial conditions.

- Well, we're going to have to leave it there. Hopefully, we'll have you back when things are more interesting and not watching that paint dry. Goldman Sachs Asset Management global fixed income and macro strategist Gurpreet Gill, thanks for joining us here today.