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The modern Fed doesn't 'like to radically surprise investors': Strategist

RiverFront Investment Group Chief Investment Strategist Chris Konstantinos and Jake Jolly, BNY Mellon Investment Management Senior Investment Strategist, discuss the most recent CPI economic data, market outlook, and the Fed's interest rate hikes amid inflation.

Video Transcript




RACHELLE AKUFFO: And there you have it, your closing bell on this Wednesday after a very tough Tuesday. We see here stocks managed to end the day, all three major indices, in the green. And the Dow just barely eking out those gains in those final few minutes.

The Dow up about 30 points to close out the day. The S&P 500 up about a 1/3 of a percent. And the NASDAQ up about 0.7%, the strongest gainer in terms of sector action markets. Materials, though, struggling the most sector wise.

Well, let's take a closer look at the broader markets and bring in our market panel. We have Chris Konstantinos, RiverFront Investment Group Chief Investment Strategist, and Jake Jolly, BNY Mellon Investment Management Senior Investment Strategist. Thank you both for joining us. So, Jake, first one to get your reaction to what we've seen today and what you think the markets are still digesting at the moment.

JAKE JOLLY: Yeah, definitely. Happy to be here. You know, today, I think we were all relieved to see that the market was a bit more calm after yesterday's sell-off, still obviously digesting that-- I wouldn't call it a hot CPI report, but I would definitely call it warmer than expected. And the market really just wasn't set up for that, right?

We had a better-than-expected, so a cooler, CPI report in July. And we were, I think, hopeful, and certainly the market was set up for progression, so another better report, and that's not what we got. We got a reversion that was a strong reminder to the market that this inflation problem isn't going to be easily solved, that, as Chair Powell commented at Jackson Hole, the Fed is going to need to keep at it.

And I think yesterday's report shows that they might have to keep at it even longer. And obviously, that pressure risk assets considerably last year, but-- excuse me-- yesterday. But the thing I'll point out there is that let's keep this in context. We had a pretty big run-up in the weeks-- or the week ahead of yesterday's report. We've lost those gains now, so we're kind of back at where we started the month.

SEANA SMITH: Chris, what's your assessment of the inflation print that we got? And does it at all change your view of what we could potentially see over the coming weeks?

CHRIS KONSTANTINOS: Yeah, sure. Great question, and thank you for having me. You know, my opinion is the headline number was more or less about what you'd expect. I mean, we've actually been trending, believe it or not, at over 8% headline CPI since 2020, so sort of right in line with what the last couple of years have looked like post-pandemic.

But I think the core part of that print was the most concerning part because when you think about things like Owner Equivalent Rent, which is items related to OER, tend to make up a big part of that CPI basket, and those tend to be a little bit less volatile than, say, food or energy. When you look at that growing over 6%, you recognize that that's going to be a big headwind for the US consumer, and that's going to stick around for a while. Those rents and owner equivalent rents tend to stick around.

So it's definitely not what the market wanted to see, as Jake very rightfully pointed out. I wouldn't say that it's changed our mind on the Fed policy going forward because we've-- for some time, we've believed that the Fed really-- in order to try to win back some credibility that they may have lost over the last year, they really need to kind of keep the pedal to the metal, if you will, in terms of rate hikes.

Also don't think-- and, again, it's a very uncertain time so who knows, but it's not my belief that the Fed's going to do a 100 basis point hike this month simply because I don't think that this era of Fed likes to radically surprise investors. They float trial balloons. They leak reports ahead of meetings to kind of give the market a little sense of what's coming. And 100 really wasn't on anyone's radar screen before yesterday.

So I think it's going to be 75. But what I do think maybe changes the reaction function a little going forward is the idea that instead of getting maybe 75 then 50 then 25, maybe we're going to get 75 and, who knows, another couple of hot CPI prints, and you might get another 75. And so I think you saw that in bond yields yesterday, the sort of recalibration towards the idea of where the terminal rate might end up being.

DAVID BRIGGS: Indeed. So, Jake, let's talk more about that 100 point hike. Do you see any likelihood of that? In the next couple of weeks, what could be the next catalyst for equity?

JAKE JOLLY: Yeah, the super jumbo hike, so I'll call the 100 basis point, I don't think it's the odds-on favorite. The Fed has pretty clearly telegraphed that 75 is, I think, what's baked into the cake. And as was just pointed out, this Fed doesn't want to surprise the market. So I don't think we're going to see that surprise 100 basis point just because of yesterday's report.

I think much more likely, we're going to see another 75 and then, potentially, more hikes or higher hikes in the November and December meeting. So we certainly could see a Fed funds rate that is above 4% by the end of the year, so a very, very high level. And I think the really important thing to point out here is that next week when we probably see this 75 basis point hike, that's when we're going to officially be into restrictive territory in terms of monetary policy. So we're going to be above sort of what is thought of as the neutral rate.

And obviously, it's been a long year of tightening, but we're really only just getting to that period. And obviously, policy fall-- has an impact on the economy with long and variable lags. And I think that's what's really making this a very difficult market. We've seen periods of optimism where the market, particularly equities, have performed very, very well. And then we've had these strong pullbacks where I think reality is really kind of crashing into that market optimism.

So you mentioned catalyst, what's going to be driving the market, well, next up, obviously, is, I think, the biggest one is comments from Chair Powell next week at the FOMC rate decision. I don't expect to hear a very different tone coming from Chair Powell. I expect that he's going to reiterate a lot of the comments that he made at Jackson Hole about staying the course, keeping at it, and really trying to avoid making a mistake.

And he was pretty clear that the mistake of previous Fed policy back in the '70s was that they tightened, but then they loosened too early. So they did a stutter, start, stop policy, and then that actually resulted in more pain for the economy. So that's why this Fed is very dedicated to getting rates high and holding them there for an extended period of time.

RACHELLE AKUFFO: So, Chris, I mean, in this environment, we've had analysts on both sides of the coin saying the 60/40 portfolio is dead, another saying, no, hold on to it. What's your take on this as investors, especially retail investors, are trying to make sense of what to do and how to balance their portfolios?

CHRIS KONSTANTINOS: Right. I'm so glad you asked me this question. So my team and I, in addition to doing tactical work, we also produce our long-term capital market assumptions, so this is very much in our wheelhouse of thinking. And I'm going to be contrarian here and say that I don't think the 60/40 is dead. In fact, I think it just got life breathed into it.

And the reason is, is we now have a legitimate risk-free rate again. As of yesterday, we saw the 10-year Treasury move well above 3 and 1/2%, probably on its way to 4%. And even though that means a lot of near-term pain both for bond and stock investors, it's actually sowing the seeds, in my opinion, of better long-term returns because when we were sitting down and trying to figure out what the next business cycle was going to look like for stocks at the beginning of the year when you had an elevated PE and you had these tiny interest rates, there's nothing attractive to allocate to.

Now, especially on the fixed income side for the first time in probably 20-plus years, we're starting to get excited about some of the yields that we're able to get in certain parts of the bond market. And I think that's-- I think that's good news for long-term balance investors because you actually have something besides stocks to allocate to and expect a decent return in.

SEANA SMITH: All right. That's two guests today in favor of the 60/40 strategy, telling us that it is not dead. Chris Konstantinos, Jake Jolly, thanks so much for joining the program today.