Inflation ‘hasn’t been working’ in the Fed’s favor, BlackRock CIO says
BlackRock Global Fixed Income Chief Investment Officer Rick Rieder joins Yahoo Finance Live to discuss the expectations for the Fed ahead of Wednesday’s FOMC meeting, rising inflation, and the outlook for a basis point rate hike.
JULIE HYMAN: There's one more thing I wanted to check on, and that's what's going on in the bond market. We're not seeing any change right now in the 10-year yield, around 3.6%. But you see on this one-year chart the sort of up and down movement that we've seen this year as people try to game out what the Fed is going to do.
So let's talk more about that challenge that the Federal Reserve has today as Chair Powell gears up to deliver the decision on rate hikes. And really, there are sort of three masters, if you will, for the Fed right now. There is stability pricing, keeping prices stable. There is keeping employment full. And now, also, there is ensuring potential stability in the financial system.
Rick Rieder is with us, BlackRock Global Fixed Income Chief Investment Officer. Of those three masters, which one or ones is the Fed going to serve today, Rick?
RICK RIEDER: You're exactly right. Those are-- I mean, two are direct. I mean, the two primary mandates are price stability, full employment. And I would say today, full employment is pretty much where it needs to be. But the one-- the indirect one is financial stability.
And listen, I think it's-- I think what they're going to do is going to try and bifurcate the discussion, meaning you use interest rate to deal with inflation. And so my sense is you get a 25 basis point rate hike today, but it's pretty close. But I think you get a 25 basis point rate hike.
And I think the Fed continues on its mission of we need to bring down what is elevated inflation. And quite frankly, the momentum of it hasn't been working in the favor of the Fed at this point. So I think that's what they use rate for. I think the commentary and I think the discussion around the terminal rate, which I think is more important, that I think is going to go to 5 and 1/4% or 5 and 1/2% or be implied as such, then I think that is you're going to pause and stop raising rates over the next couple of meetings.
And I think they'll talk about the incredible amount of liquidity they've put into the system. And by the way, the Fed's balance sheet has grown $300 billion since March 1, big number. And so I think they're going to try and bifurcate it, let the balance sheet grow, provide liquidity, deal with financial stability, and then use the interest rate mechanism to try and bring down this stubborn inflation.
BRAD SMITH: Rick, that started to get into my next question, which was really around the terminal rate. And in that bifurcated conversation, even if we did see 25 basis points today, could they effectively communicate a pause by saying they were going to keep the terminal rate at a specific level or not budge that?
RICK RIEDER: So it's a great question. So-- listen, by the way, I don't think-- the delta to the markets on you go 25 or pause today, I don't think it's that significant because I think if you go 25 and you say, gosh, we're getting to the place where we're going to start to pause and get to that terminal rate, or you pause, you say, actually, we're still want to get to that 5 and 1/4%, 5 and 1/2%, which is the way I think they're going, so I don't think that that is that significant a magnitude.
But listen, I think the idea that we've reached a rate threshold and to let long and variable lag work through the system, I think that's going to be real important. Listen, I think-- you know, I hear it all the time with commentators who describe it as, gosh, the Fed can just keep going to fight inflation. You see what plays out in the system.
And I think we're seeing that today. Financial stability, financial transmission becomes really shocked in situations like this. And so I think-- I think the Fed will talk about that. I think it would be surprising if Chair Powell didn't reference it and talk about the go forward and around, we don't need to raise rates that much further, and we're going to make sure that we provide enough liquidity to the system to withstand some of these shocks.
JULIE HYMAN: Let's talk about those shocks for a moment, though, Rick, because does it feel like they're contained at this point? In other words, everybody's-- well, not everybody. But their-- initially, of course, after the collapse of SVB, there was a lot of hair on fire, running around, particularly, I would say, on the West Coast, right? It feels like in the markets and elsewhere, things have calmed down to a considerable extent. So is there even that urgency there for the Fed to do anything about this? Has it sort of fixed itself?
RICK RIEDER: So, Julie, you know, first of all, I find that markets can be incredibly fickle. And so what they do-- one day, I would say this weekend, markets aren't open in the weekend, but there was a lot of sweaty palms on the weekend as well, a lot of work done-- the portfolio managers and all were doing over the weekend.
So listen, I think there is a structural issue today that is manifesting itself around. There is a lot of commercial real estate that is-- that's been financed over the last few years. When you raise rates this quickly, the interest-sensitive parts of the economy, and particularly where there's financing or leverage attached to it, then that's where you create stress. That's not going away tomorrow.
And so you described some of the institutions that have-- it's not just deposit outflow, but it's a fact that a lot of these rates were locked in, in 2020, 2021 when rates were significantly lower. And there's a structural problem with the interest-sensitive parts of the economy, particularly around real estate, and most intensely commercial real estate. So that's not-- it's pretty hard to fix all of that very quickly.
Again, guarantees on deposits is a powerful way to slow that down. By the way, you can invest in T-bills today. You can invest in buying things like commercial paper behind 5%, at 5 and 1/4%, 5 and 1/2%. There's a lot of alternatives to deposits and-- that today-- today's market prices are pretty attractive. So you've got a structural dynamic in the system that's going to take some time to work through.
BRAD SMITH: Yeah, Torsten Slok of Apollo noting recently the increase in money market funds and people putting money into that as an alternative as well. As I noted a few moments ago, the XLRE, real estate stocks, are doing poorly in particular today, perhaps reflecting some of what you're talking about with commercial real estate concerns. But is that a systemic risk, do you think, the idea of that repricing of some of these commercial real estate holdings?
RICK RIEDER: So if you go back to '07, '08, and you think about the size of the housing market relative to-- I mean, roughly 3/4 of the wealth in the country by number, by people is in the housing market. Commercial real estate is not nearly as intense to create what is a systemic problem. However, you get isolated pockets that can lead to contagion-- contagion risk.
So I think-- what we talked about is you think about all these markets, and you think about the next-- what happened in the last 5 to 10 years of investing when rates are at 0% or 1% or very low and negative in Europe, you have a dynamic where you can finance things, commercial real estate, private equity, et cetera, and it's very, very attractive to do it.
When you lift the risk-free rate and keep it at this level, all of a sudden those assets become very hard to roll over your financing, and that became-- becomes, like, where do you invest today? Gosh, it's pretty darn attractive to buy. You don't have to take a lot of liquidity risk, beta risk. You can invest in things at 5%, 5 and 1/4%, 5 and 1/2% that don't have a lot of risk. That changes the whole paradigm of real estate, mezzanine financing, equity-- equity financing.
By the way, the stock market-- you know, I think the stock market's just-- and we talked about it on your show in the last few months, it's just OK. If you can create the risk-free rate, most people's return targets-- gosh, if I said to you, I can get you 5% to 6% with complete safety, people would-- a lot of people would sign up for that. It means to how much equity risk do I have to take today?
BRAD SMITH: And that's definitely feels like a decision a lot of people are making right now, Rick. We are out of time for now. Rick Rieder, BlackRock global fixed income chief investment officer. Thanks a lot. Appreciate it.