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Recession could tip Fed into ‘holding pattern,’ strategist says

Citi U.S. Wealth Management Head of Investment Strategy Shawn Snyder joins Yahoo Finance Live to discuss the expectations for Wednesday’s FOMC meeting, why the Fed could hold off on raising rates, recessionary risks, and the effects of a 75-basis-point rate hike on the economy.

Video Transcript

- Welcome back, everyone. The Federal Reserve continues its fight against inflation this week. But could excessive Fed tightening tilt the US economy into a recession in 2023? That's a risk that's on the mind of our first guest this morning. And for more on what to expect from the upcoming FOMC meeting, we welcome in Shawn Snyder, the Head of Investment Strategy over at Citi US Wealth Management.

Shawn, great to have you here with us. First and foremost, from your perspective, 75 basis points, it seems baked in, cooked in at this point. But what about the next meetings thereafter? And what would the Fed really signal if they were to continue to be hawkish or aggressive with their policy then and the reaction that the US economy would have to incur?

SHAWN SNYDER: Thank you for the invite. Good morning. Listen, I think the August inflation report served as a wake up call to investors that core inflation is not going to come down rapidly. It's going to be sticky for a while. And I think that kind of reassure them that the Federal Reserve is indeed sincere and that they're going to have to go 75 basis points at this next meeting.

But I think the bigger question for investors right now is what is the terminal Fed funds rate? What is the rate at which they will go on pause? Right now, the market seems to be centered on this idea that it's going to be 4%, 4.5%. But there's some that are saying maybe it has to go north of 4%. Maybe it needs to be 5%, or at least higher than the inflation rate.

So that could mean the Fed goes even further than currently priced in or expected. And I think that is what everyone's going to be looking for guidance for on whether or not 4%, 4.5% terminal Fed funds rate is what the Fed would consider restrictive to the economy because then at that point, they can probably go on hold, go into this holding pattern, just wait and see how monetary policy affects the economy over the next 12 months.

- Shawn, I like the way you put it in your note. You said the Fed's dual mandates may become dueling mandates going into 2023. And at that point how do they weight the two mandates, which are full employment and price stability if indeed we see a spike in unemployment, for example?

SHAWN SNYDER: That's exactly right. So the Federal Reserve has two mandates. One is price stability. They want to keep inflation around 2%. And then the other one is maximum employment. What maximum employment is traditionally thought to be is an unemployment rate of somewhere between 5% to 6%.

Right now you have inflation according to the metric that they like, PCE deflator well north of 6%, according to the CPI north of 8%. And you have the unemployment rate at 3.7%. So the Federal Reserve can look at those two metrics and say, OK, price stability gets our sole attention right now.

But if they do tilt the economy into recession-- and I think that would be 2023 if it were to occur. I personally think the first half that would occur, but it could be the second half. And then the unemployment rate will start to rise. And then it makes it a little bit more difficult for them. And then they have this dueling mandates where they have to decide which one is their focus.

I do think they are willing to accept some job loss. If you do have a recession, they tend to last about 11 months on average. And the unemployment rate tends to rise about 2%, which would put the unemployment rate at 5.7%, so sort of in the range of full employment. But I just think it's going to be a more difficult task to communicate their policy if we start to see consecutive monthly job losses, which tends to be synonymous with recession. I think that will put them in a more difficult place. And I think that will put them in perhaps a holding pattern.

- Shawn, if we're talking about mid-next year for us for us entering into a real recession, that also means that we would be, what, four quarters removed from hitting a technical recession after-- or at least based on the definition of two consecutive quarters of declining GDP that we've already seen here during 2022. What's the longer standing kind of implications of that that might be felt by the average household?

SHAWN SNYDER: Well, I think there's a couple of things to consider. I think, one, the first half of 2022, we did see two negative GDP prints. I think they were sort of distorted by COVID still. You saw inventories rise sharply across retailers. They no longer need to order those inventories. They have too much inventory. And I think that has kind of resulted in this drawdown in GDP in the first half. But I think that's sort of distorted. Consumer spending still held up OK.

But I do think if you look at leading economic indicators, they are not yet suggesting that we are in a recession. But they are suggesting that we may be headed towards one in 2023. And I think if the Fed continues to tighten aggressively, then I think that is the most likely scenario. We put the odds at maybe something close to 70%.

But again, it's up to them. It is sort of in their ballpark whether they want to do this or not. I think the most likely scenario or implication for households is twofold. One, I do think inflation would come down. And if you look at the misery index in the United States, which measures the unemployment rate and the inflation rate combined, you see really, really weak consumer sentiment. And the reason is inflation is felt by many, while unemployment is most acutely felt by those unemployed.

So I think in some regards, most consumers might actually think a recession is sort of if inflation's coming down and they're staying employed. For those that unfortunately face unemployment, obviously that's going to make things even more difficult if they're facing high inflation and also losing their job. So there will be, I think, some difficult times ahead for people if that tends to be the case that we see.

And I think Europe's also facing a difficult situation. But at the end of the day, the Federal Reserve feels this is something they really need to do and that we can't live with persistent inflation. So I think that is a very tough task for them. But I think they are up to the task, and hopefully we can still achieve that soft landing.

And there are some signs might be able to do it. Economic activity does look like it's picking up in the third quarter of this year. So that's positive. There are some signs that inflation is coming down and may start to decline materially over the next nine months. So fingers crossed maybe they can pull it off. But it's looking tough.

- Fingers crossed. Shawn Snyder, thank you, Citi US Wealth Management Head of Investment Strategy. Appreciate it.