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Inflation: Global commodity prices are 'harder to handicap,' strategist says

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Edward Jones Senior Investment Strategist Mona Mahajan joins Yahoo Finance Live to how markets are adjusting to forecasts on tomorrow's Fed rate hike decision, rising global commodity prices, and inflation.

Video Transcript

- Well, so much for conventional wisdom. With inflation at a 40-year high, consumer confidence at an all-time low, and markets pummeled over recent days, Fed funds futures have shifted dramatically over a 24-hour period, now in favor of a 75-point hike at Wednesday's Fed meeting. Let's discuss that possibility with Mona Mahajan, Edward Jones senior investment strategist. Mona, let's start with that 75-point hike. Is that what you think we'll see tomorrow?

MONA MAHAJAN: Yeah. We think the Fed has essentially endorsed a 75 basis point rate hike by communicating this through various outlets. Interesting we have seen Jerome Powell in the past shift his narrative if the Fed team has seen inflation data spike higher. And we certainly saw that concern on Friday.

So I think given that data point that came through, they are adjusting their expectations now. 75 basis points for June. Interestingly, the markets have now endorsed 75 basis points for July as well and an additional two 50 basis point rate hikes over the next two meetings as well. So certainly a meaningful shift in the last few days alone.

- And Mona, Rochelle here. I want to talk about Fed credibility. Obviously, you have the Fed potentially like it's risking looking to panic with a 75 basis point hike, potentially spooking the markets. But then of course, we saw what happened when they were too slow to react. And if potentially if they do stay the course with a 50 basis point hike, how complex is this picture for the Fed right now?

MONA MAHAJAN: Yeah. The Fed is in a really tough spot. Keep in mind what we saw on Friday with inflation. The part that really moved higher and well above expectations was that headline inflation. And what drove headline inflation, of course, was food and energy prices. And when you think about global commodity prices-- and global commodity prices have been moving higher-- one, they're much harder to handicap, driven by things like the geopolitical crisis in Ukraine, the reopening demand coming from China, broader oil energy supply demand dynamics, things that are not only harder to handicap, but really harder for the Fed or central banks globally to impact.

A Fed rate hiking cycle can't necessarily bring down global commodity prices. Where we did see a little bit of optimism, a sliver of hope was in that core side of inflation started to tick downwards from 6.2%, 6% this month. We think over time this is where the Fed will have an impact. Keep in mind that their preferred measure is core PCE, partly because they know they can impact that measure more than headline. But things like cooling housing market, things like perhaps a cooling labor market. We're starting to hear more about layoffs, particularly in the tech sector.

Both of those trends will, we think over time, bring core inflation down to more moderating level. And that's really what the Fed wants to see. So we are hopeful that they will do 75 basis points tomorrow. But they continue to remain more deliberate and really more at increments that they are communicating and not this sort of shock and awe campaign for markets. So that's hopefully what they'll communicate tomorrow as well.

- Mona, as investors prepare for this possible 75 basis point hike, you can see the Dow lower once again today, off another percentage point, as well as the S&P, which entered bear market territory yesterday. Do you think that 75 basis point hike, is that largely baked into the market at this point? Or could we see more selling on that news tomorrow?

MONA MAHAJAN: Yeah. I think the markets have for now priced in the 75 basis point rate hike. And in fact, if the Fed pushes back on an additional 75 basis point rate hike, we could see actually markets breathe a bit of sigh of relief here. Keep in mind we're already down over 21% now in the S&P, over 31% on the NASDAQ. So in that backdrop, markets are really pricing in a mild recession already.

And in our view, if we do head towards-- we already think we're later cycle in this economy. If we do head towards a downturn, we don't yet see the scope for it to be a severe, prolonged downturn similar to what we saw in '07 or even 2001. And so in our view, markets are already discounting a large part of what may play out over the next call it 12 to 16, 18 months. However, could there be downside from here? Yes. We have seen in the past recessions on average down 30%. But an average recession, the downside-upside is certainly looking more interesting at these levels.

- And, Mona, how likely do you think that recession is? It next year? And what about the language coming from Powell tomorrow? Brian Belski just talked about he really wants to hear the narrative that he tells them. Last time Powell talked about a soft-ish landing. He was very clear to couch that, not saying it was an entirely a soft landing.

MONA MAHAJAN: Yeah. Look, markets are savvy. Historically, the Fed hasn't had a great track record. Of the 14 tightening cycles, 11 have ended in what we'd call hard landing or somewhat recessionary environment. And now the Fed is on this path that really is unprecedented. So 75 basis point rate hikes followed by 50 basis point rate hikes really potentially bringing the terminal rate close to 3 and 1/2 to 4%.

So we are in an environment where the Fed is pushing the consumer in a more downward path. And the path of consumption will be lower over time. And we are in a moderating growth environment. Now, is recession inevitable? We don't think so, at least this year. If we are to see a downturn, we do think it happens in 2023 time frame. There's always a lag impact by Fed rate hikes or driven by Fed rate hikes. We think Jerome Powell's narrative tomorrow will be critical. We'll also be getting a new set of economic and inflation projections, which will be interesting as well.

Keep in mind, as we said, core PCE could continue to moderate through year end. We don't think this market can mount a sustainable rally until we get signals that inflation is, in fact, moderating, in what Jerome Powell has said, in a clear and convincing manner. And I think that really what the Fed and the market needs to see before they can say in a more substantial way we can perhaps go back to 25 basis point rate hikes, which, at that point, I think that's the Fed put that the market will look for.

- And in terms of the shape of the recovery, whether it's V-shaped or U-shaped, what are your projections there? And how should people be positioning themselves with that in mind?

MONA MAHAJAN: Yeah. It's a great question because markets and investors have been used to in more recent history this V-shaped recovery, where if you look at 2020 where we had a bear market-- in 2018, we had a bear market. Both recovered within three months. Why was that? Well, it was because the Fed was able to step in, deploy that Fed put, really start lowering rates or communicating about lowering rates.

That will not likely happen this time. The Fed's foot is on the accelerator. They need to push forward to engage in this inflation battle. But we think a U-shaped recovery, longer perhaps to recover some of these losses, is possible here if we start to see inflation moderate, which is our base case by year, end particularly core inflation moderating by year end.

The Fed does have an opportunity then to communicate a more gradual path. And that really will be what drives markets then to engage in this U-shaped rebound. And we think from a 20% down currently, the downside-upside as we noted earlier could be 10% down. But in a non-recessionary correction, you could get 20% rebounds off the bottoms as well. And so certainly more interesting here. But it will take some time. And it will certainly take an improvement in the data for that to happen.

- Indeed. We do thank you for your insights. Mona Mahajan, Edward Jones senior investment strategist. Thank you for joining us.