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Investors positioning for ‘greater likelihood of a recession,’ Evercore ISI Vice Chair says

Evercore ISI Vice Chair Krishna Guha joins Yahoo Finance Live to discuss investor sentiment, inflation, additional rate hikes, banking stress, a U.S. recession, and the outlook for the Fed.

Video Transcript

- In the meantime, the backdrop for that is, of course, interest rates, right? We have seen interest rates come down. That's something that's helped out those tech stocks. And the debate over the Fed's path ahead continues, as we've been discussing this morning. DoubleLine Capital's Jeffrey Gundlach said in an interview with CNBC that the Fed will cut interest rates this year as it responds to what he says is an inevitable recession.

At the same time, Wall Street heavyweight BlackRock is saying the Fed is going to keep raising interest rates, despite what markets and investors are betting. We just heard that from Chris Versace as well. Let's find out where Evercore ISI Vice Chair Krishna Guha sits in this debate. Krishna, thank you so much for being with us, really appreciate it. So we do have this debate, maybe an unusually acute debate right now, over what the Fed's going to do next. Where do you stand on whether we are going to get more increases or even see cuts this year?


Krishna, I believe-- we're having trouble hearing you right now. So we're going to try and fix that.

KRISHNA GUHA: Let's try that again. Can you hear me now?

- Yes. Yes. We got you now, Krishna. Thank you.

KRISHNA GUHA: I'm so sorry.

- That's all right.

KRISHNA GUHA: So I think the Fed has made it pretty clear that there is much more uncertainty as to how much further they'll need to hike given the stress in the banking system and the type of credit squeeze that that's likely to generate. And so they'll be very focused on the upcoming credit data, so everything from the bank senior loan officer survey, to the actual money and credit data itself, to surveys like NFIB, which will measure from the borrower perspective how much credit restraint is coming through.

Powell, as you'll recall, was sort of guesstimating that maybe we might get a quarter point of hiking worth of tightening out of credit, maybe a bit more. I guess I'd be more in the 50 basis point sort of base case. But the real point is no one really knows. So we're going to have to observe the data very carefully over the next several weeks heading up to that Fed May meeting, and again, the June meeting beyond that.

It feels like the most likely outcome right now is that they will nudge rates up one more quarter point. I'd say the next most likely outcome is probably no more hikes at all, that after the fact, they do turn out to be done here. But if the credit squeeze turns out to be not that serious and the macro data comes in hot, we could still get two or three more hikes from here.

When it comes to cuts, I think we have to understand it's possible to get a cut, maybe even two, at the very back end of the year and a good news outcome, where disinflation is coming through rapidly. But the type of cuts the market has been pricing in earlier, more aggressive cuts, you only get that if the economy is going to a very bad place because of the banking stress.

- Is that banking stress signaling the precursory effects of or the precursory events of a recession in your opinion?

KRISHNA GUHA: So it was always the case that it was going to be challenging for the Fed to achieve this fabled soft or softish landing. And that just gets harder with the bank stress because you're clearly getting some extra restraint there, but nailing down how much is really hard. And so the Fed can screw this up either way, either by a judging that the bank stress and the credit shock is going to be a big deal and it turns out it's not, or that it's not such a big deal, and it turns out that it is.

So it certainly feels to me like recession probability, which I always thought, even earlier this year, when there was a lot of enthusiasm around, was probably still a little higher than 50/50, but that recession probability has got to have gone up. It doesn't mean it's a slam dunk. The labor market in particular has got a lot of momentum here. So it won't be easy to tip it over. But certainly, it's no surprise that investors are positioning for an outlook where there's greater likelihood of a recession.

- Krishna, I really liked a point that you made in a recent note, where you said because inflation is elevated, the bar for cutting is high, cutting rates, that is, is high and much higher than the bar for pausing or stopping hikes. And inflation has remained stubbornly elevated. Do you think that that continues, and therefore the Fed-- the Fed has prioritized the inflation fighting. I assume you think that's going to continue to be the case.

KRISHNA GUHA: So first up, I think the underlying focus of the Fed very much remains on inflation. It's true of most of the central banks. It remains, of course, though also true, that in the very near term, if the financial stability issues looked like they were getting out of hand, as opposed to maybe coming back on to some degree of control, that can trump the inflation objective in the very near term.

The Fed is trying to walk and chew gum at the same time. That's conditional on the financial stability interventions, succeeding in at least tamping down the aggregate system level stability, if not necessarily restoring the viability of all the troubled banks. But as I mentioned in that note you were kind enough to flag up, I think it's really important for folks to recognize that the bar for pausing, versus the bar of cutting, is very, very different.

I've actually felt for a while, even before the bank stressed, that the bar for pausing, once you're up in the sort of high 4's or the zip code of 5% on Fed funds and everyone agrees you're kind of restricted, the bar for pausing is not that high. But the bar for cutting is much higher.

And it's not just higher in a quantitative sector. It's harder in a qualitative sense as well, meaning that you can pause on a sort of expectation that things are going to move in a more disinflationary direction. But in principle, at least, you're only cutting upon substantial further realized progress in moving towards inflation heading back towards target.

Now, of course, in a severe enough episode, a really sharp downturn of the real economies or large negative payroll prints or a full blown sudden stop to credit, severe tightening of financial conditions, I'm pretty sure that could stomp out the Fed's focus on realized inflation progress, but again, not the possibility of such things happening, only the actual realization of it. So the punch line is we've lived in a world for decades where the Fed could cut rates preemptively when downside risks emerge. They can still come. But they can only cut now reactively. That's very different for risk.

- That is a really interesting point and good perspective. So I'm curious then what you make of the likes of Jeff Gundlach, or say, a Cathie Wood waving their arms and talking about a recession, some of them even talking about deflation in this environment. Are they just off base? Are they early? What do you think?

KRISHNA GUHA: So. again, first of all, I think if it were the case that the banking stress spread, became more severe, generated a very large disinflationary shock through the credit channel, the economy started to turn down in a serious way, and then we would get rate cuts, but again, not preemptively, upon the realization of those adverse scenarios.

When you look further out to the end of this year, early part of next year, there's a slightly different debate. And that has more to do with how you think about the underlying inflation-disinflation dynamic in the first place. And there are a number of people in the market, and I associate myself with the moderate version of this view, who feel that the disinflation process, given a bit of time, may move a bit faster than the Fed is anticipating.

And so you could eventually get to a situation, if you like, of good news cuts, the good news here being we're not cutting because the economy is contracting severely. We're cutting because the disinflation process is moving faster than we thought. We are now seeing real tangible, hard evidence of places moving back towards target in a timely manner. But that's probably not going to be the case until the very late part of this year, at the earliest.

- Should CEOs then be confident on their businesses either restabilizing, or normalizing, or even seeing the resumption of growth in the back half of this year then?

KRISHNA GUHA: I think all businesses are likely to be cautious and rightly so in this environment. We've already had a lot of bad timing, the lagged effect of which hasn't all arrived. In fact, arguably, one can interpret at least a bit of what's happened here in terms of banking stresses as part of the lagged effect of Fed tightening coming through, though, of course they didn't intend to cause stress, as opposed to a tightening up of monetary and financial conditions.

And now we have the wild card of who knows how much severity of a credit squeeze coming. So as I mentioned earlier, I think the probability that we go into some form of a recession later this year or by the turn of the year has gone up appreciably. And I think corporates would be wise to behave accordingly.

- Well, we'll see what happens, and we'll check in with you. Krishna Guha, great to get some time with you this morning. Thank you so much. Appreciate it. Evercore ISI Vice Chair Krishna Guha.

KRISHNA GUHA: A huge pleasure. Thank you.