JORDAN JACKSON: Well, I think they continue to see the hard data which continues to be relatively firm, even though the survey data continues to roll over, be very weak. When you look at ISM services, PMI, when you look at services of business confidence going forward, again, the survey data suggest that the economy is likely to come under a bit of pressure. They just aren't seeing it in the hard data yet, so that suggests that they've got to do-- they think they've got to do a little bit more.

But I have a real issue with the Fed continue to be backward-looking. And specifically when I think about the labor market, that's always the last shoe to fall. Once the labor market breaks, that's when you're in the recession. That's the definition of the recession. But we're seeing signs that I think the labor market will start to come under pressure.

I think claims data tomorrow morning will be particularly important. You're seeing a fall off in the quits rate, a rise in the layoffs rate. Those are typically precursors to a bit of weakness. And so I think the Fed should be done. I think further hikes, especially two more hikes potentially, is overdoing it.

- Sarah, I'm curious to get your take here not just on what the Fed is doing today but what all of this implies about the likelihood of a so-called soft landing and the likelihood maybe, like, could we actually avoid a recession? Is that what is implied here, and is that correct?

SARAH HOUSE: Learning that certainly in the SEP in terms of their projections, were a pretty favorable growth rates. Although I think in some ways it doesn't quite jive with the unemployment rate projections that they're [INAUDIBLE] talking about more than a one percentage point rise in the unemployment rate, which is going to take, I think, a good deal of job losses considering just the inflows of labor supply just given the demographic backdrop.

So I think overall, the S&P is still signaling that that soft landing is possible. We just need a few years below trend growth and that you'll see inflation slowly come down a little bit more slack in the labor market. But I think in some ways, the GDP forecasts and the unemployment rate forecasts don't quite fit.

- RJ, you agree?

RJ GALLO: I think Sarah makes some good points. I mean, the Fed is sending a little bit of a hawkish pause here. In that sense, I think, it confirms the market's expectation. They're revising up growth, revising down unemployment. That said, unemployment will still rise materially from here according to their dot plot.

To be Frank, I think that the Fed is trying to pull off something that's a little difficult right now. You have the FOMC statement, as Jordan mentioned, it hardly changed. The dot plot is a powerful communications tool, but it moves. It's a projection. It's not promises. I think the key here is what does Chairman Powell say from the podium.

Is he going to be able to embrace the hawkish messages that we already see? Or is he going to modify it and soften the tone? There has been a tendency for the statement and the dots to send one message and then Powell out the podium sometimes strikes a slightly-- takes a slightly different angle. So we really have to see what he says here because he's trying to explain why they're pausing even though they open the door to potentially more hikes if needed.

- RJ, I'm looking at the CME Fed Watch as I like to do. It moves a lot, to be clear, but it prices in where the market thinks the Fed is going to be. And there's a lot of diversity of opinion being reflected there. So right now the odds are running at about 43 and 1/2% that there will be no more movement up or down in rates.

But there's about a 20% chance being priced in of a cut. About a 30%, a little more chance being priced in of another quarter point hike. Like so it seems like, as you say, the market's kind of taking the dot plot with a grain of salt here.

RJ GALLO: Yeah, well, the dots have proven to be a means of communication. They have not been a very accurate projection. Go back to the beginning of this extraordinary hiking cycle, the Fed did not predict that we would be where we are today five and 1/4 to 5 and 1/2%. That's why the market is looking at the dots and taking them with a grain of salt. They need to be viewed that way.

I still think they have a powerful role, however. In any form of life, if there's a committee making a decision and they will provide projections about what they think they will do, wouldn't you want to know what they thought? That's what the dots are. They're not promises, they're projections.

Right now the Fed is telling us they think they might have to tighten a little bit more. And then they're telling us, we'll probably ease next year. That helps to allow the treasury yield curve to remain inverted as it incorporates this concept of easing in 2024, which was obviously in the market before anyway. And as a result, the dots give the Fed some forward looking projection tool that otherwise wouldn't come across as coherently.

And I think that's partly why this rate hike cycle has been pretty extraordinary and how you can have such a deep inversion because in most periods of Fed history, you didn't have the dots. You've only had dots for a couple of tightening. And if you go back to the dots in prior tightenings-- dots came along in 2012-- what you'll see is the Fed did not forecast eases in the prior projections that they made back five, six years ago. They have consistently been doing so here.

And so the market looks at the dots with a grain of salt, but does take into account the directional communication that's coming out of them. The idea that we hike now, we hold, and we'll probably ease. Of course, they move around a lot despite that overall view.

- So Jordan, as we see this sell off in stocks-- and we know following these Fed decisions and during the press conference we can get some volatility. Is what just happened negative for equities?

JORDAN JACKSON: Well I think the market reaction is basically saying, you can't keep hiking rates forever. Stock prices have got to be reflective of the rate environment. If they're going to keep hiking rates, then it's kind of hard to put a valuation on the market, a forward PE on the market of 18 and 1/2 times. Especially if you think the earnings outlook is maybe not as rosy as currently what analysts are currently forecasting, it's just hard to put a multiple if the Fed is going to keep going here.

So I'm not surprised to see markets are selling off not just from an equity perspective, but from a aggregate demand perspective. The Fed keeps hiking rates, this is going to continue to weigh on the banking stresses that we're seeing across regional banks. I think some of the economic projections aren't in line with a higher Fed funds, but also higher inflation expectations.

I'm not really sure what forward inflation outlook of the Fed, the committee members are looking at. We're anticipating a three and 1/2% handle on inflation by next month. Remember in June of 2022, month over month energy inflation was running at 6.9%, month over month 7%. The last two months used vehicle prices have risen by 4.4% in the last two months. Those things, base effects in energy, normalization in used car prices.

I've found interesting the new index that the Cleveland Fed in joint with the BLS, the new tenant repeat rent index which now more-- it looks to be more closely tracking what we're seeing in terms of rental inflation suggest some pretty significant disinflation coming from owners equivalent rent over the duration of 2023 and into 2024.

So you've got all these indicators that suggest that inflation is heading back down and suggesting the Fed doesn't need to do all this extra hiking. And so something is going to break here. And so I'm a little bit more worried and I think stocks are a little bit where it is as well.

- Yeah, RJ, let me get your thoughts on how we're seeing the market react here on the back of this Fed decision. I mean, how much of this move to the downside is justified given what Jordan just highlighted?

RJ GALLO: I think it's interesting Jordan said we're going to see something break. We already sort of did see something break. SBV, Signature Bank, emergency lending facilities that were put in place to help to relieve a stressed banking system amid the greatest monetary tightening in 40 years. We've seen some things break.

And I think the Fed in this message is suggesting they need more time to see the implications of those banking sector stresses. Nevertheless, they took the opportunity to signal in the dots that they'll tighten more.

I would argue that the dots are sort of serving their purpose as a communications tool here. They must perceive that-- enough of the FOMC members must perceive that there is a risk that inflation just doesn't cool down enough despite all the signals that Jordan mentioned. And I would echo that there are plenty of signals out there that inflation is on its way down. It's still too high relative to a 2% target, however.

And I think the Fed might be trying to send us a subtle message here. They're pausing right now. They might be a skip but they'll tell you if they had to move, they would tighten again. The dots are not promises. These can change again. But I think it fits their purpose to suggest that they have a hawkish lean so that the bond market doesn't start some huge rally and the stock market also doesn't start some huge rally which otherwise would occur if you said, hey, we're pausing, let's see what's next.

- Well, and on that front as well, Sarah, the stock market rallying is also one of the things that might make the Fed more likely to continue to tighten because it's one measure of financial conditions loosening instead of tightening, right?

SARAH HOUSE: Right. So I think what's been in some ways the big surprise here with the Fed deciding to pause whatever you want to call the meeting, is that we've seen financial conditions ease since the last meeting. And they're also down since the start of the year.

And so I think in some ways, this was a signal that, OK, we're not going to come through with the surprise. We are going to assess how the data unfolds, but we're still looking for those financial conditions to tighten. And so in some ways, the surprise came through that dot plot bigger increase in terms of that medium projection for the end of this year. Signaling that it's likely that we could see even more rate hikes than what was generally expected coming into this.

So perhaps she's a bit of a signal that maybe not a surprise at this particular meeting in terms of the outcome, but certainly ready to tighten financial conditions should it be warranted, which based on a variety of financial conditions indexes in recent months, it certainly seems to be.

- So that's the read from the Fed, Sarah. But I'm curious how you read the most recent data that came out. To Jordan's point, there are already signs here that we are seeing-- we are seeing things move in a disinflation or basically cooling down in terms of where the price pressures are. I mean, do you agree with his at least thesis that the Fed is a little behind the ball on this?

SARAH HOUSE: So I'd agree in terms of we are seeing economic activity slow. I think the pieces are certainly in place for further and in some ways more market disinflation here in the coming months. But I think that moving in the right direction isn't the same as assuredly being back towards where the Fed wants to be in terms of inflation.

So overall we've seen economic activity be incredibly resilient not just through this year, but over the intermeeting period. We've actually had economic surprises over-- on the past month or so have been by the widest margin in about a year and a half.

And when you also combine it with the inflation outlook, yes, we are looking at slower price growth ahead but core inflation is still running roughly two times the Fed's target. And this is a Fed that talks about they want to make sure it's on a sustainable downward path. And we just haven't seen that quite yet.

JORDAN JACKSON: So I think it's interesting. We're now at-- if I'm right and we get another downward move in inflation next month, that will be 12 consecutive months of inflation continue to come down from its peak last month.

I also think when you look at that the lending environment, the tightening in overall lending conditions, there's a pretty close correlation between if you look at the NFIB survey and take the availability of credit and the expectations of credit conditions going forward, that leading to a rollover in the labor markets.

Now, again, the hard data-- the labor market data is a lagging indicator, and so that's going to be the last shoe to drop. And so I think it's really important for investors to look to see what are the trends coming out of the labor market. And so it's looking at average hours worked.

I think, again, that NFIB survey suggests that credit conditions can continue to cause tighter conditions. And I try to remind investors, 52% slight majority of the private workforce is employed at a business that has 500 or fewer employees. Many of these small businesses bank at regional banks.

And so you can see an environment in which they're now having to tap those business lines of credit. Recognizing that short-term business loans have gone from 4% in July of 2020, now sitting at north of 8% today. So almost doubling. The availability of credit have become more restrictive.

And so they're going to have a real tough challenge in, I'm going to have a tough time rebuilding inventory. I'm going to have to lay off staff. And that's how you get this tighter credit conditionings broadening out to the labor market.

- What does that suggest in terms of what could be waiting on the other side of these two additional hikes from the Fed?

JORDAN JACKSON: And that's the real challenge because these regional banks are still dealing with issues both on the liability side as well as on the asset side. And that's leading into further tightening in lending conditions. And so if now I'm able to get five and 1/2% potentially or north of 5% on a money market instrument, why get a couple of basis points in my savings account?

Also higher rates are going to continue to weigh on property values. We know regional banks have outsized exposure to commercial real estate. That's going to continue to be a challenge on the asset side. And so this is-- I think they should be done. I think they've done enough.

I think there are clear trends that the labor market is going to start coming under pressure. We're already seeing the disinflation beginning to feed through. And I think adding more rate hikes-- and, again, I know-- RJ as you highlight this, this is just a projection not a promise. But I think it's signaling to the market that rates are going to be higher for longer. We want to see more tightening in financial conditions given the loosening that we've seen as of late. But I think it causes more damage to the economy.

- Well, Sarah, I mean, isn't this just-- in some ways this is a method that the Fed has, right? If the market believes it's going to continue to raise rates, it doesn't necessarily have to continue to raise rates, right?

SARAH HOUSE: Right. So it's a little bit of a game, back and forth between this communication and using that as a tool itself. But as we've seen, there's-- things can change pretty quickly in your reading periods. And so in some ways, I think, that's just the Fed's going to have to keep at it with some of this hawkish talk. And I think at some point you'll have to see that hawkish talk backed up with potentially another rate rise. And we think we will get one most likely here in July.

- It's worth noting we are about a five minutes out from that press conference starting. We'll, of course, have that live for you here with Fed Chair Jay Powell speaking after this no decision, essentially, or a pause from the FOMC today. RJ, from an investment standpoint, what does that mean? And we've been talking about what the market's reaction is today, but how do you think about going into year end, especially if the expectation is for two additional hikes from the Fed?

RJ GALLO: Well, in the fixed income side of Federated Hermes, we have been leaning a little longer duration in our portfolios. That might be surprising to folks when you consider that the short end of the curve yields have continued to back up. Two year yields, for example, are up I think 23 basis points in a relatively short order here.

But the long end of the curve hasn't risen all that much. We've been extending duration because we believe the more the Fed does now, the deeper the recession they will cause later. So the curve can stay inverted. And I think the Fed's dots just blessed that again today. Extending duration may mean that you're going to get a little lower yield than what you get in the money market fund. And we have plenty of those in my company so you can stay in that if you want.

But I think ultimately by extending some duration, you're positioning yourself for the next chapter of this book. The next chapter is when the economy slows due to the many headwinds that have emerged and will likely intensify. And the Fed finally says we've done enough on inflation, we are going to start to ease to try to avoid too deep of a downturn.

Once that-- even a sniff of that is sensed by the market, bond yields fall, you get price appreciation, and your intermediate bond portfolio will outperform your money market fund at that point in time. Calling the exact turn and cycles is very hard.

But now that we are at a point where the Fed has tightened 525 basis points, where unemployment is already starting to rise, and then we are past-- well past peak inflation. I think now is the time to leg into some longer duration positions within your individual portfolio.

We've done that in our portfolios. We actively manage all our bond funds. And we've extended duration to be long of our indices in order to take advantage for that development that we anticipate that ultimately we're going to get some price appreciation in bonds. We're getting closer to that day.

- All right, we're less than three minutes out until the press conference. But, RJ, I just want to say one thing here, which is that everybody's been talking about this recession for what seems like forever. And I know you said it's hard to time it, but like when is it? I mean, this year, next year. Is it really coming? Is it really going to be that bad? It just seems like it just keeps getting pushed out.

RJ GALLO: It does keep getting pushed out. I would suggest the recession we're going to see is one that may actually resemble what happened back in, say, 2000, 2001. You might remember that was the dot com bubble bursting.

There were many financial market implications, negative ones from that. A lot of interest rate sensitive segments of the economy slowed down. But consumers, consumer spending, roughly 70% of GDP never went negative. It's quite possible we'll see that same dynamic in this coming recession.

That means the recession is apt to be somewhat mild if consumers who right now are abundantly employed-- the unemployment rate is a 3.7%. That's just off the lows of the last 53 or 54 years. If it does rise up north of four, which I think is a reasonable expectation. The Fed certainly signals that in their summary of economic projections today.

It's possible that consumers will still have enough disposable income, will still have enough employment in the economy that the C in the GDP account and consumption doesn't actually contract. In that case, it's a more mild recession. And the Fed is not returning to a zero lower bound. They're easing maybe 50 or 100 basis points not 500 basis points, undoing what we just did. So the timing of recession, I agree, it's key.

In this business if you get your timing wrong too often, then you're just wrong. But I think ultimately this recession is coming. It's apt to be a mild one. And we'll ultimately be friendly to investors who are adding some duration now and in the next couple of months.

- Really quickly, Jordan, as we count down to Jay Powell's press conference here. What do you want to hear from the Fed Chair?

JORDAN JACKSON: I'm hoping he adopts sort of-- and he's been great at this-- a bit of a bedside manner and striking a bit of balance. I think he needs to be careful and not to sound overly hawkish and overcommit to these additional rate hikes. And recognize that acknowledge that, yes, inflation is still high, but it's working its way down. He made that very clear in his last conference, that we are already in the disinflation process. I think he needs to reiterate that message, but maybe strike a little balance.

And I think primarily, the Fed has been so focused on pushing against rate cuts in the back half of the year that almost to some degree, the talking up of rate hikes at the front-end continues to push back against the notion of rate cuts later on this year.

And so I think he should maybe emphasize that message, but he's got to strike a little bit of balance. There are still risks that are very prevalent within the economy. Inflation is, again, as we've talked about, is showing some signs of abating. So I think he's got to strike a bit of balance at the press conference.