Red-hot inflation report: Investors and analysts react to CPI data

[00:00:00] Speaker 1: We've just crossed 9 a.m. everyone. August CPI print coming in at 8.3 percent year-over-year versus 8.1 percent expected. Let's bring in Yahoo Finances' Jen Schoenberger to take a closer look [00:00:13] Speaker 2: here at these numbers. Jen? Good morning, Brad. Prices in August showed signs of easing thanks in part to cooling and gas prices but still up overall. If you look at the numbers year-over-year, the consumer price index rose 8.3 percent in August, marking the second straight month of deceleration from 8.5 percent back in July. Increases in shelter, food, and medical care indexes were the largest contributors to the monthly index. Those increases mostly offset by a 10.6 percent drop in the gasoline index. Now, if we exclude those volatile food and energy prices, the so-called core CPI, that was up 6.3 percent in August. If we look on a monthly basis, headline CPI up a tenth of a percent. But looking at core, up six-tenths of a percent, which was actually bigger than what we saw in July. Now, breaking this down category by category, looking at a year-over-year basis, food continued to go up, rising 8.3 percent. With food at home, our grocery bills, rising 11.4 percent. So still hefty grocery bills. The energy index falling 5 percent over the month as gas, as I mentioned, came down. But electricity and natural gas actually increased. So getting a net of a 5 percent increase there. Overall categories that saw price increases included shelter, medical care, furniture, and new cars, which were up 7 percent. And among the categories that declined in August, airline fares. They were actually down 4.6 percent after falling at 7.6 percent back in July. So while this may be a little bit of welcome news for the Federal Reserve here, still seeing hot inflation readings, guys. [00:02:07] Speaker 3: Yeah, the shelter number really stood out to me because that's one of the stickiest parts of inflation, right? You mentioned the year-over-year number up seven-tenths of a percent. If you look at the month-over-month advance, we were hoping for that month-over-month little bit of a decline in inflation. So this is definitely disappointing for people looking for relief. You mentioned the Federal Reserve. And of course, there's a lot of read-through from this for the Fed. Most folks in advance of this report were saying the Fed's going to go 75 no matter what. And it doesn't seem like there's anything in [00:02:38] Speaker 2: this report that would dissuade them from doing so. Yeah, Julie, I think this underscores they will go by 75 basis points next week. While this may be welcome news, that there is a slight bit of easing again, 8.3 percent on that headline number, down from eight and a half percent that we saw the month prior, the Fed really needs to see inflation come down much further. It needs to see several months of that before they are convinced that they can come off the hiking that they will need to do. So we'll certainly hear more from the Fed chair. But I would expect the Fed to remain hawkish here, remain [00:03:14] Speaker 3: committed to the fight against inflation. Thanks, Jen. Appreciate it. And you know, as you go through these various numbers and components that we're seeing here, of course, the energy relief is being reflected in these numbers, but it takes so long for that relief to then trickle through to other things. [00:03:33] Speaker 1: Right. Absolutely. And the increases that we had seen, at least of the largest categories, increases in shelter, food, medical care indexes, largest of many contributors, the BLS noting within this report for the broad-based monthly all items increase there. And so with all of that considered, you did see that 10.6 percent decline in the gasoline index. Food index, though, continued to rise. And so really what this spells out for the consumer right now is we've talked with so many of our guests and even economist Fed chair Jerome Powell himself has also said that, yeah, individuals might have to be ready to kind of brace for or just navigate through this this period of time that's going to be more extended than than desired for for some of the higher prices. Of course, we don't desire that at all. But at the end of the day, for what we're going to have to navigate through continually, the Fed noting it, some of our guests noting it, and we're going to dive into that even further with our next guest. But it's just the extent of time that the consumer can actually weather some of the higher prices. And that's a larger question as to when you will see that have more of an economic impact that is [00:04:40] Speaker 3: larger ranging as well. Let's talk more about all of this and that wide-ranging economic impact with Greg Daco. He's EY Parthenon chief economist. Greg, it's great to see you. I'm going to start very simply here. What happened? What happened to the numbers that we thought we were going to see in a little bit more relief that we thought we were going to see in the CPI print? [00:05:02] Speaker 4: I think what we saw today was that inflation has come off the boil, but it's still simmering. And importantly, it's still broad based. My eyes are going to be laser focused going forward on the core CPI momentum. And a 0.6 print month over month is not the type of reading that the Fed wants to see as evidence of cooling inflation. This was a reading that was disappointing. Broad based inflationary pressures led by shelter costs, as you just mentioned, with this pricing on the housing front still very present, as well as pricing pressures on the medical care front, where supply shortages are probably influencing prices to the upside. That is not the type of reading the Fed wants to see. This type of reading will push the Fed to act more forcefully as it really wants to see compelling evidence that inflation is coming down. So 75 basis point, I think, is a guaranteed right now for the September meeting. But we have to look towards the back end of the year and into 2023. If inflation doesn't come off, the Fed will continue to act with determination to try to regain control over inflation. Greg, looking at some of these [00:06:06] Speaker 1: categories here, the unfortunate thing is, too, that even if we look at the back half of the year, I mean, we're in the back half of the year. Let's think about that, number one. But number two, getting into some of the categories that actually did see declines, they're still set to go up towards the back half of the year. I think about airline fares where there's still so much demand, even among the leisure travelers, that the airline operators have themselves said that they're going to continue to try and navigate this period with the best pricing possible that helps them sustain their operations as well. And so, I mean, even in categories that we did see declines in for August, it still seems like there's a headwind that could potentially still rear its head once again later [00:06:45] Speaker 4: on this year. That's absolutely right. We're in a world that is rebalancing and businesses are having to navigate this uncertainty where supply and demand are still unbalanced. So what we're seeing and hearing from a lot of the clients we talked to, the executives we talked to here at EY, is that we're seeing some desires to keep prices elevated. That prevents significant downward pressure on prices and on inflation. So as we look into the end of the year and into 2023, I think we should be prepared to be in an environment where we have persistently elevated inflation and it will require some pain, as Powell has said, to regain control over inflation. Some pain in the form of reduced business activity, reduced demand, reduced hiring, potentially some increases in the unemployment rate to regain control over inflation. At this stage, it's becoming increasingly evident that without a slowdown in demand, we're not going to see an easing of inflationary dynamics. And as we know, inflation erodes consumer purchasing power and forces people to dip into their savings and to use more credit to offset that [00:07:53] Speaker 3: burden of high inflation. You know, what's really fascinating to me, Greg, is that you're talking about that consumer demand. You mentioned supply chain earlier. I mean, we've been hearing from company after company that now has swung from shortages to surpluses, right? It's especially acute in certain industries, right? We've saw huge inventory builds at many retailers. We've started to hear from many of the semiconductor makers that they are built now building up too much supply because they are seeing less demand from their clients. So is there just such enormous demand out there that it's sopping up what is now an increase in supply over last year? [00:08:33] Speaker 4: No, I think what we're seeing is that there are imbalances in very specific sectors. If you look at the goods sector, for instance, we're not seeing companies that are essentially slashing prices on a broad basis. What they're doing is essentially trying to target their discounts in a way that continues to protect their margins. Because there's so much uncertainty as to the future demand, they don't want to slash prices for everything. So we're seeing the stickiness on the pricing front, not increasing prices anymore, but being very careful and judicious as to how many cuts there are. And we're seeing the same thing on the labor front, which I think is a key source of the ongoing inflationary pressures, whereby employers are essentially being very careful as to how much they address their talent pool and not laying off excessively because they know that the value and the cost of labor has increased. That continues to maintain upward pressure on wages. Even if wage inflation may cool, the wage levels are still remaining high. And that's what we're seeing on the prices front. Prices are not falling rapidly. Even used car prices this month only fell a 10th. There are expectations that these would fall much faster in the coming months, but so far we haven't seen that turnaround. 75 basis points largely expected [00:09:49] Speaker 1: at the next meeting. But then what? And is that what the markets are thinking about this morning? [00:09:55] Speaker 4: Absolutely. I mean, markets are really not so much focused anymore on September. It seems like a 75 basis point rate hike is locked in given prior communication by Fed Chair Powell and by other policymakers. They didn't push back against market pricing for 75 basis points at the upcoming meeting next week. I think all eyes will now be focused on what happens in November, in December. The new trajectory is likely to be 50 basis points in November, 25 in December, as there are some hints that policymakers want to ease up on the pace of tightening now that we will likely have achieved a restrictive monetary policy stance. But if we continue to see prints like this, very hot prints, especially in terms of core CPI momentum on a month to month basis, that will push the Fed to press harder on the policy breaks. And perhaps it might want to hold the federal funds rate at a higher level through 2023, despite the high likelihood of a recession in the U.S. economy. That's going to be the key focus right now on markets is how high the Fed goes and whether and how long it holds. The Fed has set very high bar in terms of holding rates for the foreseeable future. Does that mean, Greg, 75 basis points, not just in September, but beyond? Potentially. I think the Fed is pretty much open to this idea that it will need to tighten faster if inflation remains stickier than expected. We've seen Powell admit that he is willing to change his mind if the data does not come in line with the Fed's expectations, the Fed's forecast. There is no preset path, I think, at this stage from a Fed's perspective in terms of easing up on the pace of tightening. So we could very well see some further large rate hikes in the coming months, especially if inflation proves stickier than anticipated. And you've seen in most recent communication from Fed policymakers that they want to avoid the errors of the past. Premature monetary policy easing is not something that they want to encounter in this tightening cycle. They want to avoid the errors of the past in the 1970s where monetary policy swung wildly and inflation expectations became unanchored and we moved into a higher inflation regime. [00:12:07] Speaker 1: All right, major averages this morning. Reflecting an unwelcome surprise, EY Parthenon Chief Economist, Greg Daco, thanks so much for joining us. [00:12:15] Speaker 5: The market to bring in our panel. Keith Lerner is the truest co-chief investment officer and Kathy Boss Jancic, Oxford Economics Chief U.S. Financial Economist. Nice to see you both on what is a very important day and an ugly day thus far for the market. Kathy, we'll start with you and take you back to what triggered it all was the inflation report. [00:12:34] Speaker 6: What caught you by surprise? Hi, happy to be with you. Yeah, it was a shocking number. Really, the core reading is what surprised us. It was up six-tenths of percent, so it was double the increase of what we expected on the month. Headline was boosted by the core, but as expected, energy prices were down sharply and food prices were up quite a bit, and that's just a continuing trend. But it's the core number, core services and core goods. Now, core services are being lifted by higher rental costs. That's not a big surprise, but you also saw medical costs, transportation costs in the service sector high, and core goods, maybe that was the biggest surprise, kind of broad-based and particularly with new vehicles continuing to rise. Keith, what's your reaction to the huge drop [00:13:27] Speaker 7: that we're seeing today? The Dow now off over a thousand points, S&P off pretty substantially, NASDAQ off just around 4.5%. What's your big takeaway? Well, first, great to be with you, [00:13:39] Speaker 8: even though we're seeing a lot of red today. I think the big takeaway is, you know, the inflation is still a problem. This kind of resets the market outlook. I think heading into this report, the market was up about 6%, hoping to see slower inflation. And if you remember, Esther George recently said that she was looking for at least three months of improvement in CPI. Well, we don't have that. We don't even have the first month. So this, again, puts the market back on the defensive. And it reinforces a key theme that we've been discussing really over the last several months is that there's scar tissue left because of the inflation side. That means the Fed is going to stay higher for longer. And I think that's going to continue to cause challenges for this market. So we remain, you know, a little bit more defensive and up in quality. [00:14:26] Speaker 9: So Kathy, how much does this latest inflation print really move the needle then? Because obviously a lot of investors sort of passing through every bit of economic data that comes out right now. [00:14:35] Speaker 6: Yeah. You know, this is potentially a big game changer in the sense that, you know, as was said, the market was anticipating we were going to see several months of improvement. And we did see improvement in July. But now the question is, was that a head fake? And is inflation much more persistent and stickier than we thought? And it may be. And that means that interest rates have to go higher for longer than expected. That really changes the calculus, right, of what the bond market's priced in. And now that the impact is below over on the equity market. What to watch going forward? I think the retail sales is the next big release on Thursday. And then beyond that, it's really how does the consumer and labor market withstand, you know, continued tightening of financial conditions led by the Federal Reserve. Our view is that we're actually going to be heading into a mild recession in the first half of next year. And part of that is really going to be the fact that earnings growth is slowing quite a bit [00:15:39] Speaker 5: and even declining. And Keith, do you agree with that on in terms of where we're headed with the recession? And how much longer do you expect this pain to continue as far as equity? [00:15:50] Speaker 8: Yeah, our base case is that the odds of recession are relatively high early into next year. We thought back in June, the market had priced in a recession prematurely. However, even after the CPI print, what this means is the Fed is going to continue to have to tighten. And we also have the most aggressive global central bank tightening we've seen in the last 30 years. So we think that is going to slow things, you know, pretty markedly by the end of the year. And we think odds of a recession next year are, you know, at least 50 percent. As you think about the overall market, I think this is going to continue to wear in the market. The big challenge right now is, as those rates are moving higher, even in the midst of a slowing economy, it's going to put some downward pressure on valuations. And you're seeing that more acutely in the growth areas of the market. Look at technology today, communication services, discretionary, all down 4 percent. That's the biggest part of the market. Those three sectors represent around 50 percent. So our message is to still remain somewhat more defensive areas like staples, healthcare, utilities, energy is the one circle area. One point I will, in a day where it's all red, I will point out one positive, maybe, you know, some offset is sentiment is already very depressed. We saw in this morning, the Bank of America fund manager survey showed global equity managers had the lowest allocation to equities, you know, in history and the highest cash allocations since 2001. So at least some of the news, at least is people are braced for bad news. And we got that today. But, you know, position is somewhat light. So that's a modest offset to the macro picture, which, in our view, is still challenging. [00:17:28] Speaker 7: Kathy, let's talk about the size of the hike that we could see next week. No more of forecasting a 100 basis point hike. What do you think is most likely? [00:17:37] Speaker 6: You can't rule out 100 basis points. I don't think that's most likely. But, you know, these were quite miserable inflation numbers, frankly. And the Federal Reserve is looking at this and saying we've got to slow down the labor market. We have to slow down demand and reduce the pricing power that companies still seemingly have. So you can't rule it out. Our view right now is probably 75 basis points next week, followed by another 75 is a possibility in November. [00:18:09] Speaker 9: So, Kathy, for people who are sitting at home thinking, oh, the housing market is cooling, perhaps things will be a little bit better. What are you what are you thinking right now in terms of what we should be piecing together from the data that we saw pertaining to housing and rents? [00:18:21] Speaker 6: Yeah. So rental prices are probably poised to continue to rise, unfortunately, until middle portion of next year, because rental prices tend to lag home price changes by about a year. Now, home prices are in the year and year rate is decelerating. And we think that could continue and may even accelerate. As you pointed out, with interest rates rising, tenure yields now climbing to 340 or so, that's going to push mortgage rates up. That's just going to make it a lot less affordable for home buyers. And that's going to put some pressure, further pressure on the housing market, which I think, but when you look at the indicators, it's already in a recession and is leading the overall economy. [00:19:04] Speaker 10: Well, important to note, like you said, we're about where we were about a week ago. So this was just the market getting a little ahead of itself. And, you know, at CapTrust, we took a little bit of money off the table on equities about a month ago for the same reason. And we don't see any reason to put that money back on yet. But we do see some positive implications, believe it or not, in the inflation numbers. So more to talk about there. [00:19:28] Speaker 5: Ryan, is this the type of sell-off you expected? [00:19:33] Speaker 11: No, I mean, I was a little surprised with CPI coming a little bit higher than expected. And I was a little bit, yeah, I was a little bit thrown off by the amount of selling that we've seen here. But again, right, we're back to where we were over a week and a half ago. And I think more importantly, you got to remember, all those CPI numbers are backwards looking. And if you look at inflation on the ground floor, if you look at, you know, everything from, you know, what commodity prices have done, right? They've come down significantly over the course of the last couple of months. Shipping costs have come down like 60 percent from Asia to the US. I think inflation is still coming down. And I think bottom line here is if inflation does come down, you know, the Fed could get a lot less hawkish later this year. [00:20:13] Speaker 9: And Christian, you said that you had a little bit of hope, a little bit of optimism in a few spots there. I would like to know what those are. [00:20:18] Speaker 10: Well, and I think it was Ryan, he just said that pretty well. You see the commodity prices coming down as we speak. And don't forget this inflation report, Just Take Gasoline, still had a 25 percent year-over-year change in gasoline prices. But we know that it's come off 20 percent off the highs, even more than that. So we're going to see the deflationary impact of that in future inflation reports. So we need to see the market get a little bit more comfortable with the direction. And unfortunately, this did not extend the downward direction in inflation numbers. But the underlying elements are there to give us a lower inflation number sometime later this year and especially early next year. [00:21:03] Speaker 7: Ryan, what about the economy? Do you think the economy is going to be able to hang on here if the Fed, in fact, is very aggressive? I know you were saying maybe they'll be a little less hawkish by the end of the year. But over the next month or two, how does that set up the economy heading into 2023? [00:21:18] Speaker 11: Well, I think the market's already priced in a lot of this inflation, obviously, that we see the Fed, how they're going to raise interest rates to the end of the year. I keep going back to the employment market. The employment market is so strong, right? I mean, at the end of the day, we still have for every two jobs, one person's looking. We saw that Jolts report. We have over 11 million job openings. And I just don't see that getting any better. I mean, every economist and strategist keeps talking about how they're going to see unemployment go up again. I don't buy it. You know, if you go to a convenience store, you go to any restaurant, I mean, some restaurants can't even stay in business because they can't find people. So I think labor is going to say very, very tight wages are going to stay strong. And if inflation is coming down, that's a pretty decent economy. And I think what you're seeing with the market right now is expectations about the economy are so, so low that we find out later on that the economy is relatively strong. That could be a huge tailwind for the market here going into the end of the year. I'm relatively bullish here, even with today's [00:22:12] Speaker 5: sell-off. All right. Christian, a lot stands down in terms of shelter today and the massive increase in rents. How tough will that prove to tame for the Fed? [00:22:22] Speaker 10: Well, the Fed doesn't really have to do a whole lot from here to tame rents. Unfortunately, it's a very lagging indicator because real estate transactions are just less frequent. But the underlying cause of deflation in housing prices is already in. With the mortgage rates getting to 6%, you've seen a lot of backing off of buyers in the real estate market. And that's going to lead to lower prices eventually. It's just a matter of time. And I would say on the food component, which was also really strong today, the initial reaction of a shopper at a grocery store is to complain about higher prices but buy pretty much the same stuff that they always have. But as that lingers on, you're going to see consumers get a little more picky and start picking the items that are a little bit less expensive on a relative year-ago basis. And you can see the food element come down in future reports. [00:23:18] Speaker 9: And so, Ryan, I know in your notes, you talk about sentiment being the biggest variable here. How would you characterize market sentiment right now and how that might perhaps affect some of the movement that we'll see going forward? [00:23:29] Speaker 11: Oh, it's not pretty. If you look at it right now, I mean, sentiment's probably abysmal. It's some of the lowest sentiment I've seen in my career. If you look at that AAI weekly sentiment indicator that comes out or survey, it's at like, you know, I think it's the lowest reading, the 24th lowest reading since the survey came to existence like 30 years ago. So I think sentiment's abysmal right now. You've got money managers sitting with way too much cash right now, you know, looking at like when the dot-com bubble burst or when we were at the the bottom of the credit crisis. We're seeing those type of cash positions sitting. So I think your bigger risk here, and I talk about this in my podcast, Pain Points of Wealth, maybe the greatest financial podcast in the country, but I digress, is, you know, if you get some positive news here, there's a lot of money that has to get into this market. You could still see a bona fide melt up. So I think, look, you got to get invested now. Dividend yields are going up this year. It's a great inflation hedge. At some point, this volatility is going to start to subside. A lot of bad news is priced into these markets. Your bigger risk here is surprises on the upside, and then a lot of money has to come into this market. I wouldn't want to be behind on that [00:24:32] Speaker 1: trend. Well, we've got much more conversation on this. Let's dive more into this market action with Lizanne Saunders, who is the Charles Schwab Chief Investment Strategist. Lizanne, always good to speak with you. First, can we get some sense of your expectation with more of the conversation that's kind of been coming forward around a potential 100 basis point hike based off of yesterday's CPI prints. That really jettisoning the probability of a 100 basis point hike higher by about 20%. Do you think that's in the cards? [00:25:06] Speaker 12: Maybe in the cards, but further down in the deck, I think, than a lot of the chatter around that. With the meeting so close, up until yesterday's CPI report, a firm expectation of 75 basis points. I'm not sure the Fed at this point, and with this narrow a window of time between the next FOMC meeting, would want to do shock and awe kind of policy. So their MO has been to move somewhat consistent with market expectations, even sometimes juicing market expectations via maybe well-planted whispers in certain reporters' ears. So I think 75 is more likely. I think what really was the implication of yesterday's hotter-than-expected CPI report was not so much the size of the hike coming next week. But the fact that we have to push into November and December, not just hikes, but maybe more significant hikes, not an easing back to 25 to 50. [00:26:08] Speaker 3: Yeah. I mean, who needs shock and awe from the Fed when you're going to get it from BLS, when it comes out with these inflation statistics, right? The economy is providing its own shock and awe, I guess, to the markets right now. Where do we go from here after the sell-off that we saw yesterday? As we talked about, the bounce that we're seeing this morning does not feel assured. [00:26:27] Speaker 12: So, you know, yesterday, although it was quite extreme, conceptually wasn't a terrible surprise. What's been more surprising to me are the days where the market, and not just days, but days and weeks, where the market seems to want to forcefully fight the Fed. Julie, as you know, I grew up in this business working for the late, great Marty Zweig, and he coined the phrase, "Don't fight the Fed." So, I'm steeped in the background of that and how important that is, especially in the type of cycle that we're in right now, combating a 40-year high in inflation. I thought the notion of a pivot made no sense at all. The only background conditions for a green light to the Fed to start cutting interest rates so soon after an aggressive tightening policy would be much more significant deterioration in the labor market from here and/or in the economy from here. So, the fact that it was sort of a bullish wrapper around that narrative I didn't think made a lot of sense. And I think the Fed continues to have to push that rates will continue to go up fairly aggressively. And once they get wherever they get to where the Fed can say, "Okay, maybe we can pull our foot off the brake a little bit," they're going to stay there for a while. And I'm not sure that the equity market has yet fully reflected that in its behavior. So, yesterday was less of a surprise. Some of the rally days in the face of news that shouldn't suggest [00:27:50] Speaker 1: it, I think, has been more of a surprise. And so, in terms of the strategy that people should be thinking through, whether they're trading desks or whether they're individual investors, when they think about how companies may have to also adjust some of their own outlooks in the guidance that we've seen thus far and where that might be actually coming down, what would your expectations be there? [00:28:12] Speaker 12: Right. So, I do think we're only at the beginning of the reversal in terms of earnings estimates and the move down for the latter two quarters of this year and the first couple of quarters of next year. You still have consensus for dollar earnings for 2022 at about 225. That's versus 208 for 2021. So, still a decent growth rate. I think those estimates have to come down. It certainly wouldn't surprise me to see us end up at the end of 2022 with an earnings number south of where we were in 2021, meaning a negative year-over-year change. And I think that has obvious implications for the market because you've got now this deteriorating E in the forward PE, which is putting upward pressure on multiples, while inflation, which hasn't been tackled yet, puts downward pressure on multiples. So, it's a bit of a push and pull right now. But there are factors that tend to do well consistently in declining estimates, declining earnings environments. And it's factors like return on equity, stronger free cash flow, positive earnings revisions, lower volatility. And those don't necessarily work when you get these pops higher, these counter trend moves on the upside. But I think those are the types of characteristics you want to look for in this ongoing period of volatility, but especially because of this [00:29:35] Speaker 3: deteriorating earnings outlook. Yeah. And these are factors that you've been talking about for a little while now as we've been in this current period. Lizanne, are they particularly concentrated in any sectors or is it sort of spread out across different sectors? I mean, we were showing a chart that you tweeted this morning about the Nasdaq 100 and the theme you were just talking about that we have seen PE multiples actually expand, even though the earnings outlook has not been great. Right. So, no, there [00:30:03] Speaker 12: isn't really a heavy concentration in any one sector to maybe marginally you find a lot of those more in the healthcare sector than other sectors. But one of the benefits and points of factor-based analysis is you don't have to make that one step up call sort of at the at the sector level first and then move to the factor level. You can apply factor-based screening across the spectrum of sectors because there are opportunities throughout the market. And I think the sector call is particularly difficult this time because we're so macro-driven right now and you're seeing this pretty rampant sector volatility. Even energy, which has been the best performing sector over the past year, has spent as many months where it was the worst performing sector as it has months where it was the best performing sector. So that kind of activity, I think it's going to drive shorter term investors crazy trying to figure out that sector call where there's been more consistency at the factor level. But yes, if I was going to point to one sector that maybe has those incorporated in a little bit more than others, it would be healthcare. [00:31:06] Speaker 3: Lizanne, just really quickly, for lack of a better term, were people you were talking to freaked out [00:31:11] Speaker 12: yesterday by what was going on? I did six virtual events and there was concern. But I wouldn't say freaking out because a lot of the concern about inflation has been there. It's always a shocking day to go through that. But if you're disciplined, you can ride through tough periods like that, [00:31:32] Speaker 1: individual days or weeks or even months. I guess for some levity at this moment, who was the musician that's on the wall behind you? I just need to know. It's a whole bunch of them. So I should turn this. Oh my goodness. This is far more expensive than we thought it was. [00:31:49] Speaker 12: I got it at a charity auction. I'm a total rock chick and it's every amazing guitarist ever. It's Jimmy Page and Jimi Hendrix and Eddie Van Halen and Jeff Beck and Clapton. So that's what sits over [00:32:04] Speaker 1: my shoulder giving me good advice. That is the conversation we need to have next time. Just go down the top 10 list of guitars. That's way more fun. That is. That is. Lizanne Saunders, Charles Schwab, Chief Investment Strategist. Thanks so much for joining us this morning. Bye, [00:32:17] Speaker 3: you guys. Seven days and counting now until the next Federal Open Market Committee meeting. Investors are eyeing a 75 basis point rate hike with risk to the upside potentially. Some economists are calling for a 100 basis point rate hike following that hotter than anticipated CPI print yesterday. We did have PPI today. That wasn't as alarming, by the way. But the inflation data was a major headwind for risk assets as peak inflation talks now quiet down, at least for now. Joining us in studio to break down the latest market action is New York Life Investments economist and portfolio strategist Lauren Goodwin. Lauren, thank you for being here. We talked earlier in the show to Lizanne Saunders who talked about that maybe 100 basis points isn't happening, but maybe we'll get more 75 basis point rate hikes, for example. How are you changing or not your outlook for rates based on what happened yesterday? [00:33:03] Speaker 13: Well, I agree with that perspective. I think we see clear evidence that inflation is nowhere near where the Fed would want it to be or even trending in that direction. I agree that 75 basis points is more likely for next week. It's plenty in one move, but risk is to the upside. Now, where I think the major changes that the market was pricing in yesterday, which I agree with as well, were for the November meeting, now 75 basis points very much in play there, and expecting the Fed to get to a 4% policy rate by the end of this year. Now, for context, at 8:29 yesterday morning, right before that inflation report was released, that was an April probability. And so there's a pretty significant change in interest trade expectations, which is why we've seen so much volatility in that 24 hours since then. [00:33:45] Speaker 1: With the volatility that we have seen over that period of time, I mean, it seems like as we were talking about even in the break, that the markets got caught flat footed here. And so for investors out there watching, what is kind of the smartest idea that they can make with their portfolio in a time [00:34:00] Speaker 13: like this? Well, keep calm is probably the the number one most important thing to keep in mind. But the other is that even though economic risks are rising, and even though we're seeing volatility, mostly to the downside yesterday, is that when inflation is this high, some of the traditionally risk off or run for the hills types of investment strategies can be a serious drag on long-term wealth creation, which is what most investors, especially on the retail side, are looking for. And so while we are moving more defensively in our portfolios, having just last week moved from an overweight equity position to a neutral one, that's still fully invested. And so then within that context, of course, we're very targeted and very tactical in in our portfolios. But staying invested feels very scary right now. And it's one of the more important things to keep in mind. To go back for just one [00:34:54] Speaker 3: second to the trajectory and pace of rate increases. Can you sort of break it down for us? Okay, so let's say they get to 4% by year end instead of next April. What difference does that make sort of in real terms [00:35:08] Speaker 13: to the economy and the markets? Oh, it's exactly the right question, Julie. And I think just as important as the pace that the Fed is moving and the change in that pace that we're all dissecting these past couple days, just as important is how long they stay at that four are now looking like more likely to be four and a quarter percent terminal policy rate. And the reason that's so important, well, twofold. One is that sticking at a higher terminal policy rate is, I think, more likely than the market expects right now. We're seeing the market pricing in the probability of rate cuts in the second quarter of next year. I think that might be a little too optimistic unless we see some meaningful decreases in inflation and meaningful cooling in the labor market fast. So what does that mean? It means that there's more pressure on the economy in the medium term. But on the investment side, that's a really interesting opportunity for fixed income. If you have some stability from the Fed at yields that savers haven't seen in a really long time, there's some really interesting opportunities for entry across fixed [00:36:09] Speaker 1: income at that time. We'd also seen, you know, for all of the different categories that we were evaluating in yesterday's CPI print, it also comes back to, with a rising rate environment, where that's going to impact people's ability to buy homes. We saw in the home buyers data this morning, bids are coming down year over year at least. And so with all of that in mind, what other parts of the economy are going to see kind of longer term implications of a rising rate environment right now? And what does the average consumer need to know? Everyday consumer who might be looking at anything from groceries all the way to [00:36:45] Speaker 13: potentially buying a home? Well, for home buyers in particular, one potential area of comfort, although not immediately, is this is a leading indicator of what's happening in the economy. It's one of the most rate sensitive sectors of the economy. We tend to see housing lead us into a recession, but also lead us out. We've already seen a lot of the pain in the housing sector. Doesn't mean there's no pain to come, but just to say that that's early. What tends to come next? Well, we start to see next, margin compression, we're already there, and then earnings revisions in the economy. Now, that's really important for equity investors. But for everyday people, it's also important because that's when you're going to start to see layoffs, potentially, when companies are seeing their earnings fall. And so that's where then, of course, the average household, looking at potentially up to 3 million jobs over the course of the next several months, more likely to be lost as the economy slows. [00:37:40] Speaker 3: All right. Of course, we continue to watch the Fed after inflation data in August came in higher than expected. Even with that PPI data today, there is still a lot of shifting expectations that has been sending the markets into the red and shifting expectations for further future rate hikes. Here to discuss all of this is Thomas Simons, Jeffrey's Money Market Economist. Thomas, thank you for being here. So as you try to game out, we've been talking to a lot of different folks about what the Fed does now. Not necessarily next week, but beyond that. I guess I want to back up for just a second, Thomas. Why are we expecting inflation to come down more and it's not happening at the rate [00:38:25] Speaker 14: that we expected or hoped? So I think that expectations that inflation, you know, I hate to use the word transitory because it's been kind of, you know, demonized in the last 18 months. But, you know, we there is still this sort of long held view that inflation is not a sustainable thing that can be generated by the U.S. economy. And that really is sort of a memory of past cycles, specifically the post-financial crisis cycle. We had this long period of time with extremely accommodated monetary policy, expansionary fiscal policy at times, and yet we had virtually no inflation over the course of a decade. So I think it was reasonable to assume that that was going to continue. You know, we pumped the economy full of stimulus, both monetary and fiscal after COVID. Initially, there wasn't really that much inflation, but now as the economy has, you know, had to sort of restart itself and there's been a lot of supply constraints, specifically in labor at this point, it's been much stickier. And quite honestly, you know, the labor market has held up very well. Wage growth has continued and there's, it's not as much of a supply story anymore. It's really demand driven. And that's much more difficult to contain once it's started to get sort of out of control. [00:39:38] Speaker 1: There have been calls or anticipations for the unemployment rate though to tick higher, even if we are to see some type of soft landing constructed. But I mean, the odds of that, you know, depends upon who you ask at this point. And so where are you expecting the employment situation to trend towards, even as we've seen some of these larger job cuts that have taken place from companies announcing [00:40:01] Speaker 14: restructuring plans most recently? Yeah, I see that there's more or less a mixed shift going on with jobs. You know, you have certain companies that have announced, you know, layoffs of various different sizes, but there are certainly plenty of others that are looking for more help. You know, we still have, you know, 11 million job openings in the labor market that are still waiting to be filled. Uh, and most surveys you see, whether it's, you know, the ISM or the NFIB small business survey, they still show this really strong demand for, for labor that, you know, they're going to continue to hire. So, uh, if we think about this in terms of just how much slack there is in the labor force, you know, for instance, how many people left the labor force at the beginning of the pandemic and have yet to return, there's really only a few more months worth of hiring at the current pace before you get to this sort of frictional point where there just isn't any more available labor. So I do think that we're going to continue to sort of see the unemployment rate trend sideways for a couple of months. Uh, once you get past that, it could actually trend lower, uh, assuming that growth doesn't fall, fall off the table, uh, you know, completely. [00:41:06] Speaker 3: Well, let's talk about that potential, right? Because you say in your note reacting to CPI that the terminal rate probably isn't going to be 4%, probably isn't going to be four and a quarter percent. It could be four and a half percent or even higher than that. What kind of damage as the Fed is trying to beat inflation with a mallet, what kind of damage is that going to do [00:41:26] Speaker 14: to the U S economy? Well, uh, it's, that's a difficult question to answer. You know, I mean, how much damage has been done by, by high inflation over the last 18 months, it's really a trade off, right? And, uh, the continued inflation at this pace would be a disaster for the economy, uh, specifically because it hurts lower income earners so much more than higher income earners. Right. And there's really very little that can be done to support those folks, uh, if inflation is going to persist at that level indefinitely. So really in order to establish a balance in the economy, we really need to take down demand pretty significantly in order to get inflation closer to 2%. And that's going to require a very restrictive monetary policy at this point. I think that if we looked at where the economy was trending over the early part of the summer and even sort of labor market and, and even in the realized inflation data, there was some reason for optimism that, you know, we had seen inflation peak, it's going to roll over, uh, as the Fed gets sort of marginally into restrictive territory, these things will continue with that momentum. But I do think that within the last month and this CPI data report yesterday, uh, included showed that a lot of the things that we saw slowing down over the summer have not continued to slow down into the early part of the fall here. They actually show some significant signs of, uh, of, of re-accelerating, you know, I mean, specific to some of the elements of the CPI report that were mentioned just earlier, you know, home furnishings, these, the data that had been moribund for, for years on, on that specific category. And, you know, just as we see gas prices come off from the highs in June and July, it looks like you're starting to see this shift as, you know, consumers are, are immediately turning that savings around and spending it on other things. And retailers are seeing that they have more pricing power than they thought. In order to get that down, we're really going to need to see interest rates rise very significantly. And the Fed can't afford to take their foot off the [00:43:21] Speaker 1: accelerator at this point. But is it that they're spending on, on those other things? And, and, and I asked that question with the mindset of, is it that they're actually spending cash that they're saving from the gas prices coming down on other things? Or are they just spending on other things and it's showing up as spending, but it's really kind of that credit spending and what type of kind of scenario does that create in the, in this broader economic equation? Yeah, we've seen some mixed signals on [00:43:49] Speaker 14: that. Yeah. Recent consumer credit data has been some of the biggest increases we've seen on a monthly basis in, in several years. If not, I believe one recently was actually a record high, but at the same time, if we look at household balance sheets, there's still a massive amount of accumulated savings amongst households from the early days of the pandemic that is, is still sitting there ready to be, to be spent. You know, we, we've tried to estimate this in various different ways, but you know, can kind of quickly think of this as last fall, uh, households had roughly 2.5 trillion dollars collectively in excess savings above the, the trend rate from 2019. Uh, only about 400 billion of that has been spent. And obviously that's a lot of money, but that still leaves roughly 2, 2.1 trillion of this accumulated savings. It's still on balance sheets that's there to continue to fuel spending. Uh, again, you know, this is a thing where there's a very significant diversity amongst different households in the income spectrum. Obviously a lot of this is held by high income earners, uh, but high income earners also tend to be some of the bigger, bigger spenders in the economy as well. So when we're thinking of this in aggregate, there's still a lot of power there. [00:45:14] Speaker 9: 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 there. The Dow just barely eating 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 third of a percent and the NASDAQ up about 0.7%, their strongest gainer in terms of sector action with 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 Constantinos, 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, I want to get your reaction to what we've seen today and what you think the markets are still digesting at the moment. [00:46:01] Speaker 15: Yeah, definitely. Uh, happy to be here. Um, you know, today, I think we were all relieved to see that the market was a bit more calm, uh, after yesterday's sell-off. Um, still obviously digesting that, uh, you know, I wouldn't call it a hot CPI report, but I would definitely call it warmer than expected. Um, and the market really just wasn't set up for that, right? We had a better than expected, so a cooler CPI report, uh, in July. Um, and we were, you know, I think hopeful, um, and certainly the market was set up, uh, for, uh, progression. So another, uh, better, uh, report. Uh, and that's not what we got. Uh, we got a reversion that was a, a strong reminder to the market that this, uh, inflation problem, uh, isn't going to be easily solved. Um, that, uh, as Chair Powell, uh, commented at Jackson Hole, uh, the Fed is going to need to keep at it. Um, and I think yesterday's report shows that they might have to keep at it even longer. Um, and obviously that pressure risk assets considerably last year, but excuse me, yesterday. But the thing I'll point out there is that, you know, let's keep this in context. We had a pretty big run up, uh, in, uh, the weeks, uh, or the week ahead of, uh, yesterday's report. We've lost, uh, those gains now. So we're kind of back at where we started, uh, the month. [00:47:12] Speaker 7: 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? [00:47:20] Speaker 16: Yeah, um, sure. Great question. And thank you for having me. Um, you know, my opinion is the, uh, 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 at, looked like post pandemic. Um, but I think the core part of that, that print was the most concerning part. Um, because when you think about things like owner equivalent rent, which is, you know, uh, items related to, to OER, uh, tend to make up a big part of that CPI basket. Uh, and now those tend to be a little bit less, um, volatile than say food or energy. When you look at that and growing it over 6%, you recognize that that's going to be a big headwind for the U.S. consumer and that's going to stick around for a while. Those, those rents and owner equivalent rents tend to stick around. So, um, it's definitely not what the market wanted to see is Jake very rightfully pointed out. I didn't, I wouldn't say that it's changed our mind on the, on the Fed policy going forward because we've, for some time, we've believed that the Fed really, in order to, uh, 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 for the metal, if you will, in terms of, uh, rate hikes. Um, I also don't think in, and again, it's a very uncertain time, so who knows, but I, it's not my belief that the Fed's going to do 100 basis point hike, uh, uh, this month. And simply because I don't think that this, this era of Fed likes to radically surprise, uh, investors, um, you know, they float trial balloons, they leak reports ahead of, ahead of meetings, um, 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 hot CPI prints and you might get a another 75. And so I think you saw that in bond yields yesterday, the sort of recalibration towards the idea of where the, the, the, the terminal rate, uh, uh, might end up being. [00:49:25] Speaker 5: Indeed. Uh, so Jake, let's talk more about that a hundred point hike. Do you see there any likelihood of that in the next couple of weeks, what could be the next catalyst for equity? [00:49:35] Speaker 15: Yeah. Uh, you know, the, the super jumbo hike, uh, so I'll call the a hundred basis point. Uh, I don't think it's, uh, the odds on favorite. Um, you know, the, the fed has pretty clearly telegraphed that 75, um, is, is, I think what's baked into the cake. And, uh, you know, as was just pointed out, um, this fed doesn't want to surprise the market. Um, so I, I don't think we're going to see that surprise hundred basis point, uh, just because of, of yesterday's report, I think much more likely we're going to see another 75 and then potentially, um, you know, more, uh, hikes or higher hikes, um, in the November and December meeting. So we certainly could see a, uh, fed funds rate that is above 4% by the end of the year. So a very, very high level. And I think, you know, the, the really important thing to point out here is that next week, when we probably see the 75 basis point hike, um, that's when we're going to, you know, officially be into restrictive territory in terms of monetary policy. So we're going to be above sort of what is, uh, thought of as the neutral rate. Um, and obviously it's been a long year of tightening, um, but we're really only just getting to that, that period. And, and obviously policy fall or has an impact on the economy with long and variable lags. Um, and I think that's, what's really making this a very difficult market. Um, you know, we've seen periods of optimism where, uh, the market, uh, particular equities performed very, very well. And then we've had these strong pullbacks, uh, where I think reality is really kind of crashing into, to that market optimism. Um, so, you know, you mentioned catalysts, what's going to be driving the market. Well, um, next up obviously is, is I think the biggest one is, you know, comments from chair pal next week, um, at the, uh, FOMC, uh, rate decision. Um, I don't expect to hear a very different tone, uh, coming from chair pal. I expect that he's going to reiterate a lot of the comments that he made at Jackson hole about staying the course, uh, keeping at it and really trying to avoid, uh, making a mistake. Um, and he, he was pretty clear that the mistake of, uh, previous, uh, fed, uh, policy back in the seventies was that they, they tightened, but then they loosened too early. So they did a stutter, start, stop policy. Um, and then that actually resulted in more pain for the economy. Um, so that's why this fed is very dedicated to getting rates high and, and holding them there for an extended period of time. [00:52:01] Speaker 9: 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 onto 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 [00:52:15] Speaker 16: portfolios. 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 longterm capital market assumptions. So this is very much in our wheelhouse of thinking. Uh, and I'm, 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 light briefed into it. And the reason is, is we now have a legitimate risk free rate again. Um, you know, as of yesterday, we saw, uh, the 10 year treasury, you know, move well above three and a half percent, probably on its weight of four. And even though that means a lot of near term pain, both for, you know, bond and stock investors is actually sowing the seeds, in my opinion, of, uh, uh, of better longterm returns because, you know, 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, of the year when you had a elevated PE and you had these tiny, uh, interest rates, there's, there's nothing attractive to allocate to. Now, um, 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, um, good news for longterm balance investors because you actually have something besides stocks to [00:53:29] Speaker 7: allocate to and expect a decent return in. All right. That's two guests today in favor of the 60, 40 strategy telling us that it is not dead. Chris Constantinos, Jake Jolly. Thanks so much for joining the program today.