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Market rally may be ‘the signal the market has been waiting for’ on slowing Fed rates: Author

The Wall Street Journal Senior Writer John Hilsenrath weighs the ongoing market rally against the impact of the Fed's interest rate hikes, in addition to discussing inflation, market volatility, and recession prospects.

Video Transcript

[AUDIO LOGO]

SEANA SMITH: Well, let's get back to the massive rally that we're seeing on Wall Street. A lot of that has to do with that inflation print that we got out this morning. The month of October showing that prices cooled much more than the Street had expected. For more on this and what this means for the broader economy and for the market, we want to bring in Jon Hilsenrath, "Wall Street Journal" senior writer. Jon, it's great to have you back in studio.

JON HILSENRATH: Great to be here.

SEANA SMITH: So I guess just, first, your reaction to that 7.7 print that we got this morning and what you think this possibly signals for Fed policy in the coming months.

JON HILSENRATH: Well, so in terms of the Fed, they signaled before the last meeting that they're considering slowing down the pace of rate increases. And this kind of backs that up. I think that they're going to want to see more evidence that inflation is slowing before they call off the rate increases. They still, I think in their mind, feel like they've got some work to do.

But-- but this is potentially a turning point in terms of how fast they have to go. And it could be a turning point in terms of how far they need to go if we see continued declines in inflation. By the way, the other thing I thought was I was really excited to be coming back here because when we talked a week or so ago, I said the CPI report is going to matter more to markets than the Fed meeting.

SEANA SMITH: And you are right.

JON HILSENRATH: And that's exactly what happened.

SEANA SMITH: Today's reaction--

JON HILSENRATH: It was--

SEANA SMITH: --proves that you were dead-on.

JON HILSENRATH: These numbers, the whole outlook hangs on the inflation picture. And we got good news for a change, so that's good.

SEANA SMITH: Yeah, we can certainly see that in the reaction.

RACHELLE AKUFFO: I mean, as we-- I mean, as we look at that, we're seeing the Dow up more than 1,000 points on the day. And as you mentioned, though, the Fed looking for more than just one good print. They're looking at a lot of different data points. Do you think this rally is a little bit premature? Are they just looking for some good news right now?

JON HILSENRATH: The market has been poised on this edge waiting to rally, really, on some good inflation numbers. It got ahead of itself-- the market got ahead of itself this summer. Everyone was talking about Fed pivot, Fed pivot because the gasoline prices started softening, a lot of people were starting to see a turn in inflation, and they thought the Fed was going to slow the pace of rate increases.

But then we got bad numbers in August and September-- for August and September, and the market tanked. So, yes, there's a risk that the market is getting ahead of itself. But if these numbers-- if we continue to see good numbers, then this is the signal that the market has been waiting for that maybe, finally, this very, very historically aggressive campaign of rate increases by the Fed can slow down.

SEANA SMITH: And, Jon, when we look at the volatility that's played out in the bond markets-- I know you wrote about this in the "Journal" just in terms of what we're seeing in treasuries-- but we're seeing that reflected in the 10-year yield today, off another 30 basis points. Certainly that volatility that we have been seeing over the last several months sticking true with today's action. I'm curious because you wrote about what this could mean, the volatility, in the Treasury markets, the reliance that we have seen of the Treasury markets on big banks. What do you think regulators are looking at. and then the potential implications of that?

JON HILSENRATH: So-- so on the one hand, falling rates looks like good news, right? It fuels the stock market. It helps to lower mortgage rates. But there's a story underneath that that you're alluding to which is really important, which is that the Treasury market has gotten huge over the last 10 to 15 years, from $5 trillion of outstanding debt to over-- to almost $25 trillion.

The problem is that the market has gotten bigger, and the bank's ability to process that market hasn't grown in line with the Treasury market, so we get a lot of volatility. Banks don't have the capital to be intermediaries on all of this Treasury market trading, so you get big up days and big down days. And today is an example of one of those big up days.

But the flip side of that is if we get some bad inflation news, it could go down a lot. So the Fed is worried about this. The Treasury is worried about this. They're worried that-- this is the most important market in the world, $24-- not only $24 trillion and it manages-- it processes the government's debt and deficits, but a lot of activity in financial markets uses treasuries as collateral for loans. So if there's disruptions in the Treasury market, we've got big problems. And so the Fed and the Treasury are trying to figure out, well, how do we get the capacity to process trading more efficiently in this market?

SEANA SMITH: So then what position does this put the Fed in because it seems like it's putting the Fed in a very tough spot when one of their priorities right now is bringing inflation down, and we're seeing that-- the effects of that in the economy?

JON HILSENRATH: Yeah, so-- I mean, so one example here is the UK. We saw a big drop in gilt markets in the UK. And the Bank of England had to intervene by slowing down its sell-off of gilts. And that worked against their efforts to hold down inflation. So the worst-case scenario for the Fed is that it's got to intervene to provide liquidity into Treasury markets at a time when it's trying to draw liquidity out of the whole financial system because that's one of the factors causing inflation.

RACHELLE AKUFFO: And, Jon, what does this latest picture do for the possibility of recession for those who don't believe were already in one? How much does this change the picture? We know that the Fed said that the path even narrower to a soft landing at the last meeting.

JON HILSENRATH: Well, so the Fed has been hoping for a soft landing in 2022. And as Jay Powell said at the last meeting that the runway is narrowing, it's going to be-- it looks harder to get-- to achieve that now than it did a few months ago because the Fed has had to push rates up so aggressively to hold back inflation. So today's inflation news is good news for the economy. It's good news for the markets, absolutely.

The worry is that it might be too late for the economy, that the Fed might already have raised interest rates so much that the processes that cause a recession might already be in place. I mean, just look at the housing market. Home prices are slowing down their growth. Home building is coming down.

There's really-- we're starting to see some wreckage in the housing market as a result of these rate increases. And so the risk is that the Fed has kind of set off a process that could lead us into a recession in 2023. The best news that everybody could get is a slowdown in inflation so the Fed can take its foot off those brakes.

SEANA SMITH: Yeah, and, Jon, to that point, it's interesting when we take a look at what's playing out in the jobs market. I know we talked with you about that last time you were on the show, but it was before we got that slight tick up in unemployment rate, right around 3.7%.

How do you think the Fed looks at that number? Because, yes, I guess it's an improvement in terms of how the Fed is looking at it. They could start paring back some of their aggressiveness. But on the flip side, we haven't really seen the weakening of the jobs market that Powell has been talking about, that the Fed has been expecting, and that many on Wall Street say need to happen.

JON HILSENRATH: To be honest with you, the way the Fed thinks about this is kind of puzzling to me. So in 2019, we had very low unemployment. We had an unemployment rate under 4%, and we didn't have much Inflation. You know, so we were starting to get a little wage pressure.

But it wasn't as bad as it is today. So now we have unemployment under 4%, and the Fed thinks it's got to work really hard to raise the unemployment rate. Well, it's just not obvious to me that that's the source of all the inflation. And the Fed seems to think that it's a big part of the inflation because when unemployment is very low, companies are forced to raise wages to keep workers, and that puts-- that gives them an incentive to raise prices, and you get this wage-price spiral.

It's just not obvious to me that you need to wish for a higher unemployment rate. I mean, I think a lot of other things, hopefully, if all goes well, could go right, some improvement in energy markets, maybe less conflict in Ukraine, maybe supply chains improving. But the Fed thinks that they want to see the job market slowing down.

I mean, it is the case that companies have a lot of openings that they can't get filled. So even if they don't bring the unemployment rate up, at the very least they want to see some of these job openings kind of taken off the board because companies were hiring so aggressively and looking so aggressively that they think that was causing some inflation.

SEANA SMITH: So, Jon, you were dead-right-- real quick-- on the inflation print being very, very important for the markets, more important than the last Fed decision. What's the next data point that you think is critical here?

JON HILSENRATH: Well, I think every inflation report. And, I mean, I'm not allowed to trade. But if I were a trader, I'd be thinking about how do I-- how do I own volatility on trading-- on CPI days, on days when the inflation numbers get printed because the market is either going up a lot, as we saw today, or it's going down a lot, as we saw in September. So it's just so much hangs on these inflation reports. I'd be geared up and caffeinated at 8:30 every CPI report.

SEANA SMITH: I'm with you. I'm with you because the reactions is always remarkable, whether it's a day of gains or massive losses, right? Jon Hilsenrath, always great to have you. Thanks so much for joining us.

JON HILSENRATH: Thank you. Appreciate it.