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Powell has been very transparent about the transitory nature of upcoming inflation: Founder & CIO

Gibson Smith, Smith Capital Investors Founder & CIO joins the Yahoo Finance Live panel with the latest market action.

Video Transcript

AKIKO FUJITA: Let's bring in our first guest for the hour. We've got Gibson Smith, Smith Capital Investors founder and CIO. Gibson, you heard Brian there give us a play by play of what we've heard from the Fed chair so far. Let me get your thoughts on this concern about the upward pressures that are building particularly around inflation. The key question here being is a temporary bump certainly a healthy part of the recovery process, or should there be concerns about more persistent inflation? How do you see that?

GIBSON SMITH: Yeah, I think that's really the ultimate question for the bond market and part of the price action we've seen over the last several months is related to changing inflation expectations. Powell and the Fed have been very transparent about the transitory nature of upcoming inflation, this base effect, which is we're coming off of some low levels. We'll see some improvements. It will show stronger. But reality, disinflation has been an issue for the economy for the last 20, 25 years.

I think the real question that the bond market is facing right now, the question that overall markets are facing, is whether or not inflation is sustainable. We will see an uptick. And if it continues to trend higher, I would expect that we'll continue to see this adjustment towards positive real rates in the bond market.

ZACK GUZMAN: Yeah. We also heard Jay Powell talking about the expectation that inflation's going to be volatile for the next year or so. And kind of on the point you're making about, you know, we've seen-- we haven't necessarily seen in the past, you know, inflation be a worry out there on the minds of investors. But as we move forward with larger and larger relief packages, potentially this one not being the last, how much does that really add to expectations changing here, since that's always important, the gap between expectations and what the Fed thinks is going to happen?

GIBSON SMITH: Yeah. And probably as important, the fact of expectations versus reality. And that's what really the markets are going to be pricing off of here. And I would expect there to be quite a bit of volatility around this. One of the interesting points around the current environment, you have a very aggressive and accommodative Fed, and you have fiscal policy playing out at the same time. We know there's another stimulus package kind of in the pipe coming.

Eventually, we will start to see a pick-up in the global economy. And if the supply side of the equation starts to kind of see some stress, and we see demand picking up, that's where we could see inflation have a more sustainable outcome. I think-- and, you know, Powell makes it very clear in his comments.

And I-- and we have to take him at his word that, you know, inflation doesn't turn on a dime. It's not one of these scenarios where you have 1.6% in one quarter and you have 3.5% in the next quarter. It's a process that takes time to kind of fuel higher rates. And the question is what's the acceleration rate of that inflation? I think we need to worry about inflation further out the curve, but the markets are going to get in front of that in terms of the pricing.

AKIKO FUJITA: On the issue about [AUDIO OUT] recovery, we did hear the Fed chair talk about the recovery slowing. Certainly, the data that we've gotten more recently does, in fact, reflect that. How necessary is this additional stimulus in the form of $1.9 trillion in order to see a pick-up on that front?

GIBSON SMITH: I think it's critical, actually. We have not fully reopened the economy. You look at different segments of the United States that some are opening, some are still closed, some of them are transitioning. You have restaurants that have gone from 25% to 50% and ultimately will be moving toward 75 and 100.

I think this is all a process that's going to take time. And, you know, we do need to keep the markets liquid. We need to keep stimulus in the system to kind of get through that period of time. The question way out-- and I think this way-out may be 12, 18, 24 months-- is what's the Fed's reaction to an improving economy? What do they do?

We had an experience a few years ago where they raised rates and started shrinking the balance sheet. That obviously created an enormous amount of volatility in markets. That's going to have to be very, very careful over the next 12 to 18 months in how they communicate and what actions they take.

ZACK GUZMAN: Gibson, in relation to kind of how you handle all of this, I mean, today's open, we saw a lot of volatility. The VIX spiked above 27. What do you make of that maybe jitters around what could have been said by Jay Powell? Of course, he's still talking, but what do you make about fears right now built into a potential pullback correction that could be looming?

GIBSON SMITH: Well, any time you're coming off of a significant run or an increase in valuations and, you know, in the bond market in particular, we're coming off very low yields. And now we're seeing corporate bond spreads and mortgage spreads back to all time tights. When you get to those kind of, you know, "the spring is wound pretty tight" moments, when valuations are high, you should expect some of these-- this volatility at certain inflection points.

And, you know, I think the market wants to believe the Fed is going to remain accommodative. The market wants to believe that fiscal stimulus is going to continue to be a theme. But it's always going to second guess it. And I think we just have to expect this level of volatility based on the run we've seen.

Earlier, we were talking about Bitcoin and the volatility we've seen in Bitcoin. It's a great reflection of some of the excesses in the economy or in the markets. And, you know, some of that volatility is, I think, to be expected.

AKIKO FUJITA: That was part of the line of questioning in this testimony. The Fed chair asked about whether, in fact, he thought that the Fed policy had contributed to some of the asset bubbles that some have said are forming in the markets right now. Gibson Smith, Smith Capital Investors founder and CIO, it's good to talk to you today.