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The jobs market has 'held up surprisingly well,' strategist says

Federated Hermes Senior Portfolio Manager RJ Gallo reviews the circumstances of the economic environment and job market amid the Fed's interest rate hikes.

Video Transcript

SEANA SMITH: All right, let's take a look at the markets here, Rachelle, with just about, what is it, 56 minutes to go until the closing bell, still looking at gains across the board. Obviously, Dow up 436 points, right around the highs of the session. And this move today comes as we're seeing yields once again move higher, 10-year yield back above 3.3.

So here to talk all about that, we want to bring in RJ Gallo, Federated Hermes senior portfolio manager. RJ, it's great to see you. This rally that we've seen in yields, the bearish bond market, seems to be intact once again. We saw yields pull back just a bit yesterday. I guess, what's your big takeaway from the action that we've seen in the bond market this week?

RJ GALLO: Well, I think that the Fed remains the dominant story. If there was anybody who held hopes that the Fed might soften their tone, those hopes were dashed at the Jackson Hole speech a couple of weeks back. I think now that the summer is over and September is underway, it's almost as if some traders shook off the dust of their vacation, read the Jackson Hole speech, and figured out that yields have to keep going higher.

We're in that camp. We think yields will continue to rise from here. And the Fed's on the way to get to the Fed funds rate to probably at least 4% in coming meetings, with the 75 basis point hike at the next meeting.

DAVE BRIGGS: And Fed gov Christopher Waller says he is prepared for another significant rate hike. The market's pricing in a 75-point hike. Do you think there's anything in terms of that inflation print that we're getting in just over a week's time that could move them from that 75-point expectation?

RJ GALLO: I mean, it's hard to-- one data point shouldn't mean too much. But if it were to somehow collapse, I think it would catch their attention. Inflation is the problem, and inflation is what they are acting against. If the CPI were to come in flat, year over year numbers reflecting that kind of dynamic as well, that might give him some pause.

I don't think, on the other hand, that that would put the Fed on hold. I think they're more likely than not going to go 75. Even with some downside surprise and inflation, we'll probably see 75. If it collapsed somehow, maybe they go back to 50. But it's sort of funny that we're even debating that. 50 versus 75, these are large increments. The Fed is very much in the game of tightening rates in order to slow demand so that inflation, which is now a clear problem, decelerates as we move forward. And I don't anticipate that we'll get a big surprise that will change that.

RACHELLE AKUFFO: So, RJ, in terms of the impact on consumer spending power, how do you see that being reflected, especially in things like earnings, going forward?

RJ GALLO: You know, consumers, especially middle income, low income consumers, for whom food and energy make up large proportions, larger proportions of their personal outlays, this has been a very challenging time. Higher income folks might complain about prices, but it doesn't affect their behavior that much. Middle and lower income folks are getting squeezed.

And that's one of the reasons why we anticipate that the economy is going to continue to decelerate. The risk of recession has risen. And the drop in real purchasing power related to the inflation shock is a big challenge here. That said, we all know the jobs market has held up surprisingly well. And it's probably because I think employers might be a little reluctant to let people go after dealing with such tight labor market conditions for last year or so, coming out of the pandemic. They're probably loathe to just let people go. They know how hard it can be to get them to come back.

So they're probably holding on to employees a little bit longer than they otherwise would in a more normal economic cycle. The post-pandemic world has not been very normal. And I think employers are being cautious. That said, we would expect the unemployment rate to continue to drift up. And as I mentioned, recession risk is much higher than it was even 6 to 12 months ago. And if we do get that recession, say, in 2023, I would think the unemployment rate would react accordingly.

SEANA SMITH: So, RJ, what does all this mean for bonds for the 10-year in particular? Because we have the 10-year right around 3.3 today. Some thoughts about whether or not maybe the selloff in bonds had been overdone. Doesn't look like that is the case, at least for now, given the fact that you're saying it's so uncertain right now, and we could very well be heading into a recession.

RJ GALLO: I think the worst of the selloff is over. It's been an extraordinarily challenging time. A variety of major bond indices, whether they be treasuries, investment grade corporate bonds, munis, they're down 9%, 10%, 11%, sometimes 15% on a year to date basis. So it's been a brutal total return environment for fixed income investors, and because yields had to rise rapidly and we started the year with very little income cushion to absorb any price loss.

I think the worst of that is over. Your inception yields, if you buy a bond fund or buy bonds today, much higher than they were back in January, number one. Number two, I think that the 10-year Treasury is probably apt to finish the year somewhere between 3.50 and 3.75. That's not that far from where they are right now. So we still think yields are rising, but we don't think they're about to spike like they did earlier in the year.

So I think that's partly why the risk assets, equities, lower quality bonds, every now and then, stage these rallies. You've seen them-- you saw it in stocks. You saw it in lower quality bonds in the summer. And then August proved to be difficult as the Fed's message was reaffirmed.

Our view at Federated, stay up in quality within the fixed income market. You can get back into bonds again slowly. We still think there's some price loss to go, but the worst of the price losses is probably behind us.

DAVE BRIGGS: And we can end on that, somewhat upbeat. RJ Gallo, good to see you, sir. Enjoy the weekend.